Growth stocks can deliver excellent investor returns as a company’s profits grow and its share price rises. This guide will explain how growth investing works, what growth shares are, and explores several of the London Stock Exchange’s top growth stocks.
What are UK growth stocks?
Growth stocks are shares of companies whose sales and earnings have grown — and look likely to continue — beyond the sector average, the market average, or both.
There are many factors that could set a UK growth stock apart from the pack. It might have a cutting-edge product that puts its competitors in the shade and delivers exceptional revenue growth. A business might also grow profits at breakneck pace thanks to a successful acquisition-based growth strategy.
Growth companies might also operate in an industry or sector that’s growing rapidly. Today this could, for example, apply to a UK stock that builds electric vehicles, provides cloud-based software that help people work remotely, or supplies healthcare services.
A stock could also have strong growth prospects based on where they operate. For instance, a bank that does business in an emerging market like Asia could generate stronger earnings growth than one in Europe. Faster economic and population growth in Asia, along with low financial product penetration, means that company sales could grow far more rapidly here.
Top growth stocks in the UK
Let’s look at three UK stock market companies whose earnings have been rising strongly in recent years.
|Growth stock||Market cap||HQ||Description|
|Games Workshop Group (LSE:GAW)||£1.97bn||Nottingham, UK||A designer, manufacturer, and retailer of tapletop gaming products|
|Water Intelligence (LSE:WATR)||£119m||Palm Springs, US||A spotter and repairer of water leaks|
|Softcat (LSE:SCT)||£2.5bn||Marlow, UK||A provider of IT services|
Games Workshop Group
Games Workshop Group is a giant in the realm of tabletop gaming. Thanks to popular platforms like Warhammer 40,000, it has built a large and loyal fanbase in its 40-plus years of existence.
The quality of its miniatures, and the depth of the folklore it’s created around its gaming platforms, gives it a massive edge against its competitors. The business has also been developing its position in overseas markets and spent heavily on its e-commerce operation, too.
Games Workshop is currently exploring ways to boost the royalties it receives from licencing its intellectual property to mass media.
The big-selling Total War: Warhammer III video game launched in early 2022 illustrates the massive potential here. These steps into mass media could also considerably boost sales of Games Workshop’s miniatures, games, and books.
During the four fiscal years to May 2021, Games Workshop grew annual earnings per share at an average of 45%. City analysts expect expansion to have slowed to low single-digit percentages last year, and for the business to record a similar rise this year.
Water Intelligence helps to solve the problem of water leaks. Through its sophisticated equipment it detects, finds, and fixes leaks for residential, commercial, and municipal customers.
Preserving water is becoming increasingly important as fears over climate change and water scarcity balloon. So there is an increasing drive towards finding and repairing leaks to help preserve the precious commodity.
Water Intelligence operates in the US, UK, Canada, and Australia. Creaking infrastructure in these places is resulting in increased incidences of water loss and thus growing demand for the company’s services. Climate change is increasing the rate of such events as well by putting even more strain on pipes and other critical infrastructure.
It’s why earnings per share at this UK growth stock have risen at an average rate of 42% during the past five years. City analysts think, too, that earnings will grow an extra 9% in 2022.
Softcat provides a broad spectrum of IT services to businesses. Profits here have risen strongly as the digital revolution has taken off. And its market-leading range of solutions has led to partnerships with some of the world’s largest tech companies. Its partners include Microsoft, Lenovo, Cisco, and Apple.
In the five years to July 2021, earnings per share rose at an average of 24% per year. City forecasters predict growth to cool to 9% in fiscal 2022.
This UK growth share offers investors a chance to capitalise on several fast-growing tech trends. For instance, Softcat designs cloud-based infrastructure for businesses and helps them improve their networks. Demand for such services is growing strongly as flexible working practices take off.
The company also provides cyber security solutions that can protect users from the growing threat of electronic attacks.
Are UK growth stocks right for you?
Essentially, a growth-based investment strategy is built around making profits from share price growth. This is quite different from income investing where individuals try to create wealth by receiving dividend payments.
Ideally one should try and invest in UK growth stocks as early in a company’s life as possible. Strong earnings growth feeds into electrifying share price growth, so the earlier you can get in the more you could potentially stand to gain.
This doesn’t mean that the window of opportunity is narrow, however. Some UK growth shares have been generating robust profits increases for many years and would appear in good shape to continue doing so.
Take rental equipment specialist Ashtead Group (LSE: AHT). Prior to the pandemic, the FTSE 100 share grew annual underlying earnings per share at an average of 30% between financial 2015 and 2019. This was thanks to an aggressive acquisition strategy designed to boost market share.
City analysts expect Ashtead’s earnings to keep growing solidly, too, as infrastructure spending in its core US market picks up and the firm remains committed to sales-boosting acquisitions. Profits have been rising again following initial Covid-19 disruption and analysts think earnings per share will rise 14% this fiscal year and 12% next year.
Ashtead shows how a successful UK growth stock has the potential to supercharge one’s returns over the long term. This business provided the biggest return on investment of any Footsie share during the 2010s, rising at a compound annual growth rate (CAGR) of 43% (according to data company Refinitiv).
But investors need to remember that many stocks with bright growth prospects trade on high price-to-earnings (P/E) ratios. And this can be extremely risky to investors.
It’s natural that companies with exceptional potential should command a premium. The problem is that these expensive shares can be sold off heavily when their growth potential begins to wane.
Tech stocks, for example, tend to attract sky-high valuations. And they have been some of the worst-performing stock market constituents in 2022 as the global economy has struggled.
Expensive US tech stocks Netflix, Meta, and Amazon have been among the most famous casualties this year on signs of slowing growth. In the UK, technology-focused growth stocks like IT services provider dotDigital Group and video game developer Team17 Group have also fallen sharply as earnings have come under the spotlight. Both businesses traded on P/E ratios above 40 times around the start of the year.
Buying UK growth stocks doesn’t always yield instant results. Some firms take time to deliver strong growth (or any at all) at the beginning as they focus on increasing revenues at the expense of profitability. Here you are buying potential rather than tangible rewards. More established growth shares, however, can offer the best of both worlds.
Royston Wild owns shares in Games Workshop Group and Ashtead Group.