Many investors have an understandable aversion to growth stocks that have become hits on Wall Street. That's because soaring optimism can be detrimental to your returns due to the rising valuation it brings. And the fact that companies frequently fall short of these elevated expectations boosts the risk that you'll purchase shares just before sentiment turns negative.
Yet some growth stocks are trendy for good reasons that extend beyond simply rising sales. Focusing on businesses that bring more to the financial party, including strong cash flow, market share, and profit margins, can limit your risk of overpaying for hype. Let's look at a few prime examples of popular growth stocks worth adding to your watchlist today.
1. Lululemon Athletica
It's not hard to see why Lululemon (LULU 1.31%) has bucked the negative stock-return trend in the retailing industry this year. The athleisure specialist last reported a blistering 20% second-quarter sales increase compared to the 2% uptick that Nike announced. That boost was partly due to its increasing store base, but Lululemon also achieved 9% higher sales at its existing locations.
It isn't sacrificing profits to achieve this growth, either. Gross profit margin recently rose to 59% of sales from 57% of sales a year earlier. Operating income is similarly strong at 22% of sales. "Our Q2 results highlight the ongoing strength of the business amid a dynamic operating environment," CEO Calvin McDonald told investors in late August.
Investors have responded to all the good news by pushing the growth stock up 17% so far in 2023. Those short-term returns could evaporate if a recession develops in the key U.S. market. But Lululemon still has a bright future as it pushes into new geographies, demographics, and product categories.
2. Microsoft
It is likely that hype around artificial intelligence (AI) is helping push Microsoft's (MSFT 1.82%) stock higher in 2023. There's much more to get excited about with this massive tech business, though.
The company has an excellent market-share position in key niches ranging from cloud services to cybersecurity, for one. That diversity helps explain how sales could rise at a double-digit rate in fiscal 2023, even as the PC market has been shrinking. Microsoft is also sitting on a huge cash pile and generates ample free cash flow each quarter. Finally, investors will be hard-pressed to find many other companies routinely generating an operating profit margin above 42% of sales.
These successes have helped Microsoft shareholders outperform the market this year despite weakening demand in some IT spending areas. Yet the current valuation of less than 12 times annual revenue leaves room for further positive returns ahead.
3. Netflix
Investors have some high expectations around Netflix's (NFLX -0.63%) upcoming earnings report on Oct. 18. The streaming video specialist in mid-July said it is projecting accelerating sales growth in the second half of the year thanks to several tailwinds, including the crackdown on password sharing and the rollout of its ad-supported plan.
And unlike peers such as Roku, Netflix is already producing ample profits today. Free cash flow was $1.3 billion last quarter, and management is targeting an operating profit margin of roughly 20% of sales for the full fiscal year.
That success should give Netflix the resources it needs to maintain its prime market-share position while still sending cash to shareholders and paying down its debt. That's a recipe for continued positive returns for investors, even following the stock's rally in 2023.
