Understanding Growth Stocks

Explanation

You have to be careful in distinguishing between a growth stock and a growth firm. A growth stock need not represent a growth firm. Rather, it is defined as a stock that has consistently generated returns higher than those justified by the risks. Such a situation arises either because the company has surprise windfalls or because at some point in the past, the market underestimated the firm's growth potential. Note that this is not in violation of efficient markets theory, which says that on average, investors correctly impound the available information in the stock price, though in any individual case, the market might over- or underestimate the impact of the new information on the value of the firm.