The past two years have shown the power of investing in growth stocks. The S&P 500 has returned nearly 60% during that time, powered b y some of the fastest-growing stocks on the market.
It’s why investors frequently turn to them. Investing in growth stocks can be exciting as it promises high returns from the rapid expansion of the companies involved. However, this investment strategy comes with its own set of risks that investors should carefully consider before diving in.
Growth stock investing is great — until it’s not
Artificial intelligence has turned many stocks into growth stocks that defy all reasonable valuation attempts
Growth stocks are companies that are expected to grow at an above-average rate compared to other investments. Nvidia (NASDAQ:NVDA) is a great example. Its stock rocketed nearly 1,000% over the last 24 months as artificial intelligence mania gripped investors. It was up almost 2,250% over the last five years.
That is until the Chinese AI lab DeepSeek disrupted the AI market. NVDA stock suffered the biggest single-day loss of market capitalization by a company in one day in the history of stocks because of it. Most other chipmakers tumbled hard, too.
These companies often reinvest their earnings into further development rather than paying dividends, which means the investor’s return is primarily through an increase in stock price (Nvidia, though, does make a very small, nominal payment).
Risks of growth stock investing
Investing in growth stocks might earn you high rewards, but the risk of losing it all is a very real danger
It means growth stocks are subject to exceptional risk with little downside protection to soften the blow. Below are three of the top risks investors face when buying growth stocks.
Volatility. As Nvidia’s stock showed over just the past week, volatility is the first major risk to be aware of. Especially those companies in emerging sectors like technology or biotech, significant price swings should be expected as their value is often tied to future expectations rather than current earnings. If market sentiment changes or the company misses growth forecasts, the stock price can plummet rapidly.
High valuations. Investors tend to pay a premium for the promise of future growth, which can inflate the stock’s valuation relative to earnings, sales, or other key metrics that might not be justified by the company’s current financial performance. If growth slows down or there’s a market correction, these stocks tend to fall more dramatically than value stocks because their high prices were based on optimistic projections.
Lack of profitability. Because growth stocks are spending heavily on research and development or marketing, they typically operate in the red. Amazon (NASDAQ: AMZN) was a famous case for that. It was unprofitable for all of its early growth phase and Wall Street often predicted it would crash. But the e-commerce giant is the exception that proves the rule.
If these investments don’t pan out, the company might struggle financially, which could hurt the stock price. Anyone remember Pets.com from the early 2000s?
Eyes wide open
The speculative nature of many growth stocks makes investing riskier, especially in economic downturns when funding dries up, and consumer spending decreases.
So, despite the allure of substantial gains, these stocks also present risks like high volatility, overvaluation, and the uncertainty of profitability. Investors must weigh these risks against potential rewards, understanding that patience and a tolerance for risk are crucial when investing in growth stocks.
If you’re still interested in taking the plunge, consider these two growth stocks to buy today.
Dutch Bros (BROS)
Drive-thru coffee shop Dutch Bros (NASDAQ:BROS) is the first growth stock to buy. It is the third-largest national coffee chain behind Starbucks (NASDAQ:SBUX) and Dunkin with 1,000 locations, and shares of this fast-moving business are up 143% over the past year.
It is expanding its footprint through a strategy known as “fortressing,” that floods a particular market with locations to capture mindshare and saves on marketing expenses.
Dutch Bros also has the benefit of being profitable, and having those profits grow every quarter even as it opens new locations. The coffee slinger is also enjoying organic sales growth and is seeing more return customers every quarter.
Its stock is not cheap on various pierce-based metrics, but you’re paying a premium for quality and growth that shows no signs of quitting.
Netflix (NFLX)
The second growth stock to buy is a familiar name, Netflix (NASDAQ:NFLX). The movie stream won the streamer wars, fending off every established and new service that emerged during the Covid pandemic. Not even Disney (NYSE:DIS) has figured out how to make streaming consistently profitable, yet Netflix makes it look effortless.
Sales, profits, and subscribers all surged in the fourth quarter as new programming and sports offerings drew in record numbers of viewers. It added 18.9 million new subscribers to its rolls, double what Wall St. expected. Its profits also doubled and it initiated a huge, $15 billion stock buyback program.
With advertising now offering a potentially lucrative new revenue stream, Netflix is primed to be a winning growth stock investment for years to come.
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