A growth stock is a stock that is increasing in value as opposed to providing a steady stream of income in the form of a dividend. Growth stocks tend to have a lower price-to-earnings ratio (P/E) and earnings per share (EPS); in some cases the P/E and EPS can be negative. This makes sense given that they are spending more money than they are generating in order to maintain their growth trajectory.
Companies such has LinkedIn Corporation LNKD 191.43 +0.03 0.02% are investing their revenue back into the company. To see where a company is investing its money, an investor will need to review financial statements such as the 10-Q and 10-K reports. Let’s take a look at LinkedIn’s 2016 1st Quarter 10-Q and see why this growth stock has a negative EPS. Though the company generated $860,650,000 in the first quarter of 2016, it spent $301,786,000 in sales and marketing, $237,620,000 in product development, $127,650,000 in general and administrative expenses, $142,285,000 in depreciation and amortization, and $117,528,000 in the cost associated with generating the $860,650,000 in revenue. The takeaway is that LinkedIn spent more money than it generated. The strategy appears to be working; looking back, the company generated roughly $473,000,000 in the first quarter of 2014 and $638,000,000 in the first quarter of 2015.
Growth stocks do not normally distribute dividends, which means they do not have a dividend yield. This is logical given they have little to no revenue and can even have negative revenue. An investor who buys a growth stock isn’t interested in a steady stream of income; he or she wants the overall share price to increase. A growth stock’s corporate strategy, if proven to be successful, rewards investors with an increase in the value of the price per share or in stock split. A stock split is when a company’s board of directors has determined that the price per share is trading higher than its peers. To generate investor interest and make the price per share more attractive to smaller investors, a company will split the stock. Whatever the denomination—2 for 1, 3 for 1, etc.—the number of shares and the share price will still equal the market capitalization before the stock split. An investor is rewarded with more shares than he or she originally purchased through a brokerage account.
Finding a growth stock that will consistently increase in price per share is difficult. Not every growth stock is going to enjoy a stock split or substantially increase in price per share. In the case of LinkedIn, the company’s stock has never split, but the value of each share has dramatically increased since the company’s initial public offering (IPO) on May 16, 2011. LinkedIn opened at $83 per share and as of today (June 6, 2016), it is valued at $135.66 per share. It is important to believe in the company’s strategy and understand the risks a company will face due to competition and relevance in the market. If a growth company loses a critical team member or founder, the company may lose its way and the stock price may drop. Think back to May of 1985, when Steve Jobs left Apple Inc., and the success that the company basked in when he returned in August of 1997.