What are ASX growth shares?
A growth share is a company that investors expect will grow at a faster rate than the broader market, which is typically measured using the S&P/ASX All Ordinaries Index (ASX: XAO) or S&P/ASX 200 Index (ASX: XJO).
Growth companies are more likely to be smaller, up-and-coming businesses than larger, well-established companies. They typically focus on growing their sales and market share, possibly delaying profitability to become industry leaders. As growth businesses mature, the focus naturally shifts to maximising profits.
Growth companies tend to reinvest their earnings during the growth phase rather than paying them out as dividends. This means investors will often not receive income for holding growth shares. But many will choose growth investing due to the potential for share price growth, which translates into capital gains.
Why invest in ASX growth stocks?
A growth investor is looking for shares with faster earnings growth than other companies, which means they may outperform the market over time. Growth stocks tend to have high valuations on a price-to-earnings (P/E ratio) basis but are usually also growing their revenue at a higher rate than their peers.
Growth companies tend to have unique product lines, intellectual property, or technology that gives them a competitive advantage over others in their industry. This can help them build a loyal customer base and significant market share.
To retain that advantage and ensure their long-term growth, they must continually invest in developing new products and technology.
Top growth shares on the ASX
Choosing top growth stocks can be tricky as the performances of smaller companies with potential for strong capital gains depend heavily on variables such as competition, customer base and market volatility.
Here are three top ASX growth share performers ranked by market capitalisation from high to low.
| Company | Description |
| Resmed CDI (ASX: RMD) | Develops and manufactures medical devices and software to diagnose and treat sleep-disordered breathing, chronic obstructive pulmonary disease (COPD), and other chronic diseases |
| Xero Limited (ASX: XRO) | A cloud-based accounting solution provider |
| NextDC Ltd (ASX: NXT) | A leading data centre operator poised to benefit from the structural shift to the cloud |
ResMed
With a focus on the diagnosis and treatment of sleep apnea, COPD, and other chronic respiratory diseases, ResMed manufactures continuous positive airway pressure (CPAP) masks and machines as well as life support ventilators. Ongoing high demand for sleep and respiratory care products and solid growth in the software-as-a-service (SaaS) business contributed to a 9% revenue increase (on a constant currency basis) in the first quarter of FY23.
Resmed recently announced the acquisition of mementor, a German pioneer and health tech startup that develops and distributes digital medical products in sleep medicine and related areas. mementor offers somnio, the first permanently approved digital health application (DiGA) in the field of sleep medicine that is eligible for customers to claim reimbursement.
ResMed’s long-term strategy is to help 250 million patients by 2025 through increased manufacturing of sleep and respiratory care devices and driving accelerated adoption of digital health solutions. Digital health solutions cost less and provide better clinical outcomes for patients. This could also mean sustainable share price growth for ResMed’s shareholders.
Xero
Xero provides cloud-based accounting software to small and medium business customers. Founded in 2006, the company now has more than 3.5 million subscribers and leads the cloud accounting market in Australia, New Zealand, and the United Kingdom. Revenue grew 30% in 1H FY23 to $658.5 million. According to the CEO, this result underlines the quality of the business and the value it generates as more customers join.
Subscriber numbers increased by 16% in the first half of FY23, while annualised monthly recurring revenue grew by 31% to $1.5 billion. Earnings before interest, tax, depreciation, and amortisation (EBITDA) increased 11% to $108.6 million. Xero reported strong revenue growth across all regions.
Xero has been successful in expanding overseas and taking on incumbent software. The company now has its eye on the North American market. If it can repeat its success there, growth in customer numbers should continue for some time to come. Currently, Xero prefers reinvesting cash generated to drive long-term shareholder value.
NextDC
NextDC provides data centre outsourcing solutions, connectivity services, and infrastructure management software. The company provides co-location services to local and international organisations with a nationwide network of data centres in Australia.
The company reported record results in FY22, exceeding FY22 EBITDA guidance. Data centre services revenue increased 18% over the year to $291 million. Underlying EBITDA increased 26% to $169 million. NextDC continues to grow its connection-rich customer ecosystem and remains ideally positioned to capture the benefits of prevailing industry tailwinds driven by the growth in cloud computing and accelerated digitisation.
NextDC has provided FY23 guidance for data centre services revenue in the range of $340 million to $355 million, with underlying EBITDA in the range of $190 million to $198 million. Digital transformation is driving outperformance in NextDC’s partner and network sectors as they support the enterprise’s shift to hybrid and multi-cloud.
What to look for when investing in growth shares
Investors in growth stocks expect strong growth in the underlying company. This can often result in high price-to-earnings (P/E) ratios, making growth stocks appear overvalued. When a company is expected to grow strongly, many investors remain willing to invest even at high P/E ratios. This is because they anticipate the stock price will appreciate over the long term.
This can be contrasted to value investing, where investors seek good quality stocks trading at attractive prices with lower PE ratios. We can also contrast it to income investing, where investors seek dividend stocks to provide ongoing income.
Growth stock investing means seeking stocks with substantial room for capital appreciation. Overall, these tend to be newer and smaller companies or industry disruptors. They usually offer unique services, products, novel technologies, or intellectual property. They may operate in high-growth industries like technology or biotechnology.
Growth stocks perform best when interest rates are falling, and company earnings are on the rise. Remember, growth stocks only remain growth stocks while investors think there is a good chance for significant company expansion. Once companies have fulfilled this potential, they may no longer be classified as growth stocks.
Pros of investing in growth shares
Potential for capital gains: By definition, growth shares have substantial potential for capital appreciation. For example, a biotech company working on a new disease treatment could be considered a growth stock because there is potential for huge profits and capital gains if the treatment receives regulatory approval.
Exposure to emerging trends: Change in societal trends can be hugely impactful for growth stocks. For example, COVID-19 accelerated the adoption of online shopping, boosting the share prices of companies like Amazon.com, Inc during the pandemic.
And the cons
Lack of dividends: Growth stocks typically do not pay out dividends because the company earnings are usually reinvested to accelerate growth further. Investors in growth stocks tend to anticipate making gains via capital growth rather than dividend income.
Risky: Because growth shares typically do not pay dividends, the investor’s only opportunity to earn money on their growth shares is when they eventually sell them (hopefully at a profit). But this may not be possible if the company does not do well.
Are ASX growth stocks a good investment?
Whether growth shares are a good investment for you depends on your financial circumstances and investing goals. Growth shares are more likely to appeal to investors with a long-term time horizon seeking capital growth. They may be less suitable for income investors, as they often do not pay dividends.
The share prices of growth stocks can also be volatile, moving as the market mood shifts. This means investors in growth shares need a reasonable tolerance for significant share price moves in the short term. Still, growth shares can prove lucrative over the long term, providing patient investors with big rewards in share price increases.