Top growth stocks
Growth stocks aim to outperform the wider market. We explain what you need to know and outline some of the best growth stocks to watch.
What is a growth stock?
A growth stock refers to a company that is expected to see its financial performance and share price outperform the wider market. They tend to be smaller stocks or startups that are gaining momentum in disrupting their industry and often boast a unique selling point.
Pros and cons: why invest in growth stocks?
The investment case for growth stocks mostly boils down to one thing: share price appreciation. As suggested in the name, these stocks are focused on growing and this means they are reinvesting any money that they are making. It is rare for a growth stock to pay a dividend (but there are still plenty), and it is common for them to be burning through cash and be unprofitable. The lack of dividends means many growth stocks are unsuitable for income investors that target steady and established companies with generous and reliable payouts.
Growth vs value stocks: which have the highest returns?
The size and potential of growth stocks mean share prices can be extremely sensitive. One contract or announcement can make or break a company. For example, a pharmaceutical growth stock can see its share price skyrocket if its new drug wins approval from regulators, or plummet to zero if trials don’t go well and it has nothing else to fall back on. Ultimately, growth stocks are geared to head higher, but they are generally more vulnerable. Those investing in growth stocks have confidence in the company’s prospects and valuation, but it is twice as easy to lose value as it is to gain it in the first place. The potential rewards can be huge for growth stocks, but so can the risks.
How to identify and pick growth stocks
Although most growth stocks are small or fledging companies, they can also be large market leaders. Take Amazon as an example. It is the largest cloud-computing company in the world and the first name to be mentioned when discussing ecommerce, but the company does not pay a dividend and reinvests all of its money because it is still chasing growth. Amazon is in the top five most valuable publicly-listed business in the world, worth $870 billion, but the company is still expanding and diversifying into new areas and its share price continues to find higher ground. Even someone who made an investment in Amazon recently has made huge sums. A £1000 deployed at the end of 2015 would be worth £2600 in late October 2019.
Still, all growth stocks share some characteristics regardless of their size. The first is an ability to report financial results that are significantly better than established peers. If the UK banking industry saw average growth in profits of 2% but a smaller challenger bank reported 10% growth, then this would suggest it is outperforming the wider market. The second feature of a growth stock is that it has faster growth in share price than peers and rivals. The 160% increase in Amazon shares since the end of 2015 compares favourably to the 61% rise in the Nasdaq Composite and even the 108% increase reported by the Nasdaq-100 tech index. The third characteristic is that the stocks are poised for growth with a clear catalyst in the making. Take a junior mining company that is building a new gold project. Construction is expensive and it can’t make any income until after it is built, but once the mine is finished, then the valuation and investment case for that company completely changes. Investors always slap large discounts on these types of companies, but these usually melt away once they have delivered and are generating income. Look for companies that are set to reach key milestones in the near future.
How to trade and invest in growth stocks
You are not entitled to dividends if you trade shares and you don’t own them outright, but you can use leverage.
Use IG’s CFD services to speculate on share prices. You can also practice your trading strategy by opening an IG demo account first, which allows you to try out your trading strategy completely risk-free.
Growth Exchange-Traded Funds (ETFs)
Investors may also want to consider using exchange traded funds (ETFs) as a way of gaining broader exposure to high growth stocks. These ETFs invest in fast-growing companies with the hope of matching or outperforming benchmark indices.
For example, the Vanguard Growth ETF, one of the largest growth ETFs on the market, aims to track the performance of the CRSP US Large Cap Growth Index. This means it focuses on larger companies that are still growing fast, like Amazon. Meanwhile, the Vanguard Small-Cap Growth ETF invests in smaller businesses that are more commonly associated with growth stocks.
You can find an ETF to suit any investment strategy you desire by using IG’s ETF Screener.
Top 5 UK growth stocks
Below is a small selection of UK stocks that look set to outperform the wider market both in terms of their financial performance and share price over the near future. We have included some larger players that pay dividends as well as some smaller, more typical growth stocks. They are organised by the size of their market cap on 24 October 2019:
4imprint (£828 million)
4imprint makes and distributes a wide array of promotional items for businesses, such as giveaway products, embroidered apparel and displays for trade shows. The company is based in Wisconsin and serves over 100,000 businesses in the US and Canada, and has an office in Manchester serving the UK and Ireland. Still, 97% of its revenue comes from North America.
4imprint shares have risen 19% over the last six months, comfortably outperforming its wider sector, which has remained broadly flat over the same period. Shares have jumped 13% over the past three months compared to a 4.8% decline in its sub-sector.
The company’s latest financial results covering the first half (H1) of 2019 were strong and suggested momentum is building rather than waning. Revenue rose 16% year-on-year (YoY) and pre-tax profit jumped 22%. In the same period the year before, revenue rose 17% but profit rose just 1%. Although the company continues to expand, it is highly cash generative, allowing it to pay a dividend. The interim dollar payout rose 20% and the sterling one increased 29%.
4imprint said at the halfway mark that it expects to deliver annual results 'slightly above' market expectations. And it has set itself long-term targets that have given investors confidence. The company is aiming to make $1 billion in annual revenue by 2022 compared to the $738 million delivered in 2018. Revenue growth is expected to accelerate this year and beyond because 2018 was regarded as an 'investment year'. It has recently finished expanding its Oshkosh distribution centre in Wisconsin and it is already looking at expanding it again.
4imprint is cash generative, profitable and pays a dividend – all of which are not usually associated with growth stocks. But the stock has delivered exponential growth since around 2012 and shows no signs of slowing down. Three brokers currently have Strong Buy ratings on the stock while two have a Hold recommendation (as of 24 October).
Avon Rubber (£546 million)
Avon Rubber is known for being a leading provider of advanced respiratory protection masks for militaries, law enforcement and fire departments around the world. However, just under a quarter of its revenue comes from milkrite | InterPuls, which provides milking equipment to farmers. This makes the stock both unique and diverse. Plus, it is highly cash generative – converting over 91% of adjusted earnings in the six months to the end of March – and pays a dividend, with the interim payout raised 30%.
Avon Rubber has delivered extraordinary growth in a sector that has remained almost stagnate. Shares have jumped 42% over the last three months while the wider aerospace and defence sector (considering most of its sales are in this category) has edged just 1.6% higher.
The outperformance over recent months was driven by the company’s announcement that it was buying 3M’s ballistic protection business for an initial £75 million, which has been regarded as a good fit for the business and complimentary to its masks. The protection suit business is already profitable and underpinned by existing contracts with the US Department of Defence, having generated $85 million in revenue and earnings before interest, tax, depreciation and amortisation (EBITDA) of $10.8 million – equal to more than a third of Avon Rubber’s annual EBITDA in 2018.
The acquisition won’t be completed until the H1 of 2020, setting the stage for growth to accelerate from next year and beyond. It is still growing organically and has enough cash to consider more acquisitions. Plus, a new $340 million contract for its masks means its medium-term outlook has 'significantly strengthened'.
ITM Power (£224 million)
ITM Power is a pioneer in two areas that are hot with investors: renewable energy and energy storage. The company has developed technology that allows surplus renewable energy to be converted into hydrogen, which can then be used when it is needed. The need for energy storage has risen as more renewables come online. This is because renewable energy is intermittent and can’t be stored and used like gas, so ITM’s plants convert renewable energy into a form that can be kept and injected into the system as and when needed. It is also trying to use this same system to provide hydrogen to power vehicles because it is the 'cleanest fuel available'. It sees hydrogen as a key fuel even as electric cars become more popular, mostly because of issues with infrastructure and range. A hydrogen car is filled up like any petrol or diesel car and can comfortably cover 300 miles plus on a single tank, neither of which is true for an electric car.
ITM shares have risen 22% in the last three months, four times more than the wider alternative energy sector. In fact, the ITM share price has more than doubled over the past six months.
The company is unprofitable, partly dependent on grants and research funding, and yet to commercialise its technology. However, the company has made enough progress to get investors excited. It had a non-contracted commercial pipeline of £379 million at the end of September. It recently announced Linde, one of the world’s largest suppliers of speciality gas, has invested £38 million and formed a joint venture to help sell its plants to more clients. It counts a number of big-name businesses as customers, including Royal Dutch Shell, National Grid, Engie, Toyota, Honda and Anglo American. It is also working with Shell to roll out its hydrogen refuelling stations in the UK, with eight stations open to the public with another seven under construction.
The investment by Linde (part of a wider equity raise and open offer) has provided a cash for the business and an important cornerstone investor. It continues to win new contracts and has proven it can attract large businesses with its niche technology. ITM shares have proven volatile in the past and have experienced huge drops before (shares plunged by nearly 60% between September 2017 and March 2019), but the foundations of the business are stronger than ever.
Scotgold (£37 million)
Scotgold is a gold miner with a difference. The company is developing the Cononish gold and silver project in the Scottish highlands. When initial production began in the middle of 2016, Scotgold made the 'first commercially produced gold in Scotland'. The company is now edging closer toward full-scale production.
Scotgold shares have soared 139% over the past three months, well ahead of the 1.5% rise seen in the FTSE Gold Mines index. Scotgold shares have also gained nearly four times as much as the index over the last six months. That rise is even more impressive considering the UK’s largest gold stocks, such as Fresnillo, have actually lost ground over the last six months.
There have been issues while developing Cononish, but the worst of its problems should be behind it. Scotgold had to recently push back first production by two months to the end of February 2020, but investors have still got excited and sent shares soaring. Its latest update on the potential of the project has forecast Cononish could generate £101 million in EBITDA, £68 million of net cash flow and boast an average operating margin of 59% over its lifetime even if gold prices averaged just $920 per ounce. For perspective, spot gold has not traded below the $1000 mark since late 2009.
Plus, the company says that 'no premium from the sale of "Scottish gold" has been assumed' when drawing up its figures. Some have suggested Scotgold could emerge as a unique play because of the state of sterling. With the pound weaker (but who knows for how long?), the company could see a tailwind by selling gold in dollars but producing it using costs denominated in sterling.
Creightons (£25 million)
Creightons describes itself as the 'home of beauty, wellbeing and lifestyle brands'. The company designs and manufactures a range of skincare, haircare and other wellness products. Its top brands include BAMbeautiful, Feather & Down, and The Curl Company.
Creightons shares have jumped more than 31% over the last six months, a great performance considering the FTSE Household Goods index has dipped 0.6%. The stock has managed a 4.1% increase over the last three months, which again compares favourably to the 2.3% decline seen in the wider sector.
Creightons shares started to gain momentum in the days before it released annual results for the year to the end of March 2019. The firm reported a 26% jump in revenue, saw its operating margin rise to 6.6% from 4.7%, and pre-tax profit jumped more than 80%. Plus, despite its tiny size, the company pays a dividend, which was almost doubled in the last financial year.
Much of the improvement has been down to the fact it recently finished expanding production capacity and adjusting its supply chain to source more lower cost components from Asia. This improved operational structure, has laid the foundations for its financial performance to improve further and it is actively looking for more brands to buy. For example, it recently acquired the Balance Active Formula brand. It described this as a 'relatively small transaction', but said this should provide a £1.2 million boost to annual revenue.
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