Typically, these companies are increasing profits faster than average and instead of paying them out in the form of dividends are reinvesting them to help develop their businesses.
As a result, the quid pro quo for choosing a share specifically for its growth potential is often (though not always) a lower than average income yield from the dividends. (The yield is the dividend expressed as a percentage of the current share price. If a share priced at pounds 1 has an annual dividend of 5p, the yield is 5 per cent. But a share costing pounds 2 with a 5p dividend will have a yield of 2.5 per cent.)
Some growth shares have an almost negligible yield. From a tax point of view this is ideal for most investors. For most people there is no capital gains tax to pay on growth, because the level of growth falls within the annual capital gains limit of pounds 6,300 - whereas most investors will have to pay income tax when they get their investment return through the dividend.
Growth shares are often found among smaller companies at the cutting edge of technology. There is much more chance of a small company rapidly doubling in size than a large, well established, blue chip business.
The corollary of this is that the investor must accept extra risk. A company developing a wonder drug for cancer could sweep the market if successful, but may lose everything if its research proves fruitless. An established company may produce less growth but prove a safer investment. That said, growth shares can also be found among the largest UK companies.
All share investment is supposed to be for the long term and this is especially so with growth stocks. Growth stocks can have volatile share prices and you may have to wait patiently to see your shares grow significantly in value. Advisers say you should look for solid increases in company profits over several years rather than spectacular short-term leaps. And some of them prefer companies that have seen growth in their core business - organic growth, as opposed to growth through takeovers and acquisitions.
In a low-inflation environment you want to look for shares from which you expect real growth over and above inflation. For example, pharmaceuticals companies (including firms such as Glaxo and SmithKline Beecham) and technology or multimedia companies are expected to bring out new products for which there will be a high demand. Here are some current recommendations from stockbrokers.
Matthew Orr, of Killik & Co, plumps for Psion. He discovered the company's products while browsing among the shops at Heathrow airport and decided to do a bit of background research. "Psion is the world leader in hand- held computer organisers, ahead of Sharp and Hewlett-Packard," Mr Orr says. "Their computers are programmable, like a PC."
The company is now selling in the big US market and expanding into the Far East. "We like to encourage people to invest in companies that are international," he says.
Psion is working on a product that makes the hand-held organiser a telephone as well. Shares were recently trading at about pounds 10. A year ago the price was pounds 3.80.
Eric Hathorn, of Henderson Crosthwaite, likes Vodafone. While the growth of mobile phones in the UK will not continue at its recent breathtaking rate, Mr Hathorn says: "Analysts are convinced of the massive potential overseas, especially in Australia and South Africa. It's a well managed and clearly focused company."
The recent share price of 261p compares with a low of 83p in 1991 when Vodafone was sold by its former owner, Racal.
Nigel Gilland, of John Siddall & Son, backs Robert H Lowe, a company operating in a niche area of textiles, printing and packing. The share is described as a speculative buy. The company's sportswear arm is a supplier to well-known names such as Adidas, Reebok and Puma.
"The forward order book is buoyant with orders from both new and existing clients and further improvement in sales and margins seems likely in 1996," says Mr Gilland.
Peter Hollins, of Albert E Sharp, likes BSkyB, which occupies a healthy and growing niche. The company has a big presence in the UK media and has the financial muscle to bid for the best programmes - witness its recent forays into televised sport. Satellite, cable and pay-per-view are growing markets and BSkyB is well placed in this area, he says.
Trevor Smith, of Waters Lunniss, the stockbroking arm of Norwich & Peterborough building society, goes for Sage, a company that produces computer spreadsheets for small company accounts. Mr Smith believes that Sage has tapped into a growth market. The firm is expanding at a fast rate and has acquired a similar company in France. The share was recently trading at 413p, up from its 1995 low of 133p.Reuse content