What Are Growth Stock Mutual Funds?

Definition & Examples of Growth Stock Mutual Funds

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Growth stock mutual funds primarily invest in growth companies, which are typically younger firms or in hot industry sectors expected to grow at a faster rate than the overall stock market.

What Are Growth Stock Mutual Funds?

Growth stock mutual funds buy and hold growth stocks. Most investors are looking to grow their assets over time, and growth stock mutual funds are an excellent tool to achieve this investment objective.

Growth stock mutual fund managers are buying stocks of companies that have great potential for future earnings above and beyond the overall market, even though their price valuations seem expensive compared to the rest of the market. This growth expectation can be higher than current price and earnings suggest.

Two growth funds are Vanguard Growth Index (VIGAX) and Fidelity Growth Company (FDGRX). A growth fund won't always feature the word "growth" in its name.

How Growth Stock Mutual Funds Work

Technology stocks are good examples of what growth stock mutual fund managers buy for their portfolios. When Facebook (FB) stock was first offered to the public in 2012, its valuation was approximately $100 billion. The year prior, in 2011, it earned roughly $1 billion.

A simplified valuation represents the "present value of future cash flows." In translation, if Facebook maintained its $1 billion annual income, it would take 100 years for an investor to earn back what they had invested. However, as incredible as this growth rate seems, Facebook tripled its price over the next three years, through 2015.

By 2017, Facebook was among the largest growth stocks on the market and by 2018, the standout growth stock had averaged over 50% annualized return for the past five years. The first quarter 2020 saw Facebook with a $220 billion market cap on roughly $80 billion in revenues. In October 2020, Facebook's market cap was over $800 billion, its earnings $22 billion, and its price-to-earnings ratio went down from 100 to 36.

A growth stock investor today is betting that companies like Facebook will grow at a much faster rate than most other companies. In the example of FB stock, although the price fluctuated over its first three years of history, growth investors, growth stock mutual funds, and technology sector funds investing in Facebook enjoyed healthy returns.

As the name implies, growth stock mutual funds typically perform best in the mature stages of a market cycle when the economy is growing at a healthy rate.

The growth strategy reflects what corporations, consumers, and investors are all doing simultaneously in healthy economies—gaining increasingly higher expectations of future growth and spending more money to do it.

Again, technology companies are good examples here. They are typically valued high but can continue to grow beyond those valuations when the environment is right. Growth stocks pay little or no dividends. The value is in the growth of the underlying stock, capital appreciation, and capital gain.

Types of Growth Stocks

Another example of growth stocks is consumer discretionary stocks. Also called consumer cyclical stocks, these stocks invest in companies that manufacture or provide products or services that are not necessary. These products and services include luxury items, hotels, and entertainment.

Investors should keep in mind that growth stocks can have temporary periods of extreme fluctuation and that growth stock mutual funds are best for aggressive investors with long-term investment time horizons, such as 10 years or more. Even though growth funds can have high returns in any given year, they also tend to decline more than the average stock fund during bear markets.

Alternatives to Growth Stock Mutual Funds

Value stock funds are those investing in companies seen to be trading at a price lower than business fundamentals would suggest. Retirees are more likely to invest in value funds because of the income generated through dividends.

Key Takeaways

  • Growth stock mutual funds invest in companies that are emerging or expected to grow at a higher rate than the overall market.
  • These stocks perform best when the economy is in a growth mode.
  • Technology stocks are typically included in growth stock portfolios.
  • Retired investors often prefer a more predictable value stock that generates income through dividends.