• Growth stocks can be a great way to earn returns in excess of the overall stock market.
• Identifying a good growth stock requires looking past valuation and identifying market trends and the companies behind them.
• A great growth stock has several identifiable characteristics.

Investing in growth stocks can be a great way to earn life-changing wealth in the stock market. The key, of course, is to know which growth stocks to buy and when.

Many growth stocks suffered major losses in 2022. While the S&P 500 index crashed more than 19%, the S&P 500 Growth index fell 30% for the year. Some growth stocks fell much more, with stock prices cut by half or two-thirds. But growth stocks rebounded in 2023, outpacing the overall market. Still, there may be room for them to continue outperforming.

Here’s a handy guide to help you get started investing in growth stocks. With these tools and strategies, you’ll be able to position your portfolio for long-term success with growth stocks.

What is a growth stock?

Growth stocks are companies that increase their earnings faster than the average business in their industry or the market as a whole. Growth investing, however, involves more than picking stocks that are going up.

Often, a growth company has developed an innovative product or service that is gaining share in existing markets, entering new markets, or even creating entirely new industries. The market tends to reward businesses that can grow faster than average for long periods, delivering handsome returns to shareholders in the process. And the faster they grow, the bigger the potential returns.

Unlike value stocks, high-growth stocks tend to be more expensive than the average stock in terms of profitability ratios, such as price-to-earnings, price-to-sales, and price-to-free-cash-flow. Despite their premium price tags, the best growth stocks can still deliver fortune-creating returns to investors when they fulfill their awesome growth potential.

That said, growth stocks took a beating in the market in 2022, and they haven’t fully recovered despite strong performances in 2023. Meanwhile, the total return for the S&P 500 since the start of 2022 turned positive by the end of 2023.

High inflation had put pressure on growth stocks since it reduces the future value of their expected earnings. Additionally, supply chain constraints affected the ability of some to expand, while other macroeconomic factors were slowing the entire economy. However, the downturn may give long-term investors a buying opportunity while growth stock prices are low.

They can be found in a variety of industries, both within the U.S. and international markets. And although all the stocks on this list are larger businesses, smaller companies can be fertile ground for growth investors, too.

A great way to invest in a wide variety of small-cap growth stocks is via an exchange-traded fund (ETF) such as Vanguard Small-Cap Growth ETF . This fund tracks the performance of the CRSP U.S. Small Cap Growth Index, which gives investors an easy way to invest in roughly 580 small-cap growth companies all at once.

Importantly, the Vanguard Small-Cap Growth ETF has an ultra-low expense ratio of 0.07%. This means investors will receive almost all of the fund’s returns, with only a small amount in fees going to Vanguard. (An annual expense ratio of 0.07% equates to only $0.70 in fees per $1,000 invested annually.)

How to find growth stocks

To find great growth stocks, you’ll need to:

1. Identify powerful long-term market trends and the companies best positioned to profit from them.
2. Narrow your list to businesses with strong competitive advantages.
3. Further narrow your list to companies with large addressable markets.

Identify trends and the companies driving them

Companies that capitalize on powerful long-term trends can increase their sales and profits for many years, generating wealth for their shareholders along the way. Here are some examples, along with the companies that can help you profit from those trends:

• E-commerce: As more people shop online, Amazon, Shopify, and Etsy are well positioned to profit within the U.S. (and many international markets). Mercado Libre holds a leading share of the online retail market in Latin America. While consumers started returning to physical stores in 2022, e-commerce still has tons of growth potential as an industry.
• Digital advertising: Meta (formerly Facebook) and Alphabet (which owns Google) own the lion’s share of the digital ad market and are poised to profit handsomely as marketing budgets shift from TV and print to online channels. Amazon has built a massive advertising business, which continues to expand into new formats. Even Netflix has come around to advertising as a way to increase its subscriber base and boost its revenue.
• Digital payments: Block (formerly Square) is helping accelerate the global shift from cash to digital payment forms by allowing businesses of all sizes to accept debit and credit card transactions and giving consumers easier access to cashless payments.
• Cloud computing: Computing power is migrating from on-premise data centers to cloud-based servers. Amazon’s and Google’s cloud infrastructure services help make this possible, while Salesforce.com provides some of the best cloud-based enterprise software available. The rise of artificial intelligence (AI) will require vast amounts of computing power that cloud providers are ready, willing, and able to offer.
• Cord-cutting and streaming entertainment: Millions are canceling their cable subscriptions and replacing them with less expensive and more convenient streaming options. As the global leader in streaming entertainment, Netflix offers a great way to profit from this trend, but it faces growing competition from other media companies.
• Remote work: Remote work became necessary for many organizations during the COVID-19 pandemic. While many companies are pushing employees to return to the office, people have grown comfortable working from home and are resisting. Companies making remote work or hybrid work easier should continue to benefit from the sea change caused by the pandemic.
• Electric vehicles: The world is shifting from its reliance on gasoline to using electricity to power vehicles. According to a survey of industry executives, half of all auto sales could be EVs by 2030. Tesla is the leader in the space, with its lineup of vehicles and its battery technology.
• AI: Companies have recently poured billions into accelerating their AI development and applying it to their businesses. Nvidia has been a big beneficiary since it designs the chips used to train many large language models (the foundation of generative AI). Alphabet, Amazon, and Microsoft (MSFT -0.15%) also benefit from growth in AI applications, as many run on their cloud computing platforms.

The key is to try to invest in these trends and companies as early as possible. The earlier you get in, the more you stand to profit. However, the most powerful trends can last for many years, even decades, giving you plenty of time to claim your share of the profits they create.

Prioritize companies with competitive advantages

We saw a big sell-off in many tech-focused growth stocks in 2022. Many top growth stocks’ share prices were slashed by more than 50%, but some of the biggest stock market losers of the year turned out to be the biggest winners in 2023.

If you can identify stocks of companies with strong competitive advantages being sold off along with the rest of the market, it can be an opportunity to generate massive returns as they recover. Some competitive advantages are:

• Network effects: Meta’s Facebook is a prime example here. Each person who joins its social media platform makes it more valuable to other members. Network effects can make it difficult for new entrants to displace the current market share leader. Meta’s 3 billion users across its family of apps certainly make it unlikely that a new social media company will displace it.
• Scale advantages: Size can be another powerful advantage. Amazon is a great example in this category because its massive global fulfillment network is something its smaller rivals will find extremely difficult to replicate.
• High switching costs: Switching costs are the expenses and difficulties involved in switching to a rival’s product or service. Shopify, which serves as an online retail system for more than 1 million businesses, is a perfect example of a business with high switching costs. Once a company begins using Shopify as the core of its online operations, it’s unlikely to go through the hassle of switching to a competitor.

Find companies with large addressable markets

Finally, you’ll want to invest in businesses with large addressable markets — and long runways for growth still ahead. Industry reports from research firms — such as Gartner (IT -0.95%) and Insider Intelligence, which provide estimates of industry sizes, projections for growth, and market share figures — can be very helpful.

The larger the opportunity, the larger a business can ultimately become. And the earlier in its growth cycle it is, the longer it can continue to grow at an impressive rate.

Take action now to capitalize on innovative companies and emerging industries. Start investing in growth stocks and watch your wealth flourish. The time to act is now!”