Supernormal growth stock: What drives them?

Introduction

Every company experiences a complete business cycle over time. Starting from the startup phase, they enter the growth phase, followed by the maturity phase. These companies eventually reach the transition phase and finally either reach the stable phase or begin to fade. 

This is often reflected in the stock growth in the market. However, a few companies experience something known as supernormal growth, and as a result, their stocks provide returns that are significantly higher than the returns from the overall market.

So, what exactly is a supernormal growth stock and what drives it to grow at this phase? Let’s find answers to these questions in this blog! 

What is supernormal growth stock?

A supernormal growth stock is a financial security that experiences an exceptionally high growth rate for a specific amount of time and then reverts to its normal levels of growth after this period. For a stock to be classified as a supernormal growth stock, it should experience this heightened growth rate for at least a year. 

During this supernormal growth phase, these stocks surpass all the market indices and performance and, hence, are the most lucrative and attractive options for investors. 

So why exactly does this happen? Consider a scenario where a new startup’s novel product suddenly experiences a surge in demand. In this situation, the rise of demand for the company’s product can be reflected in the stock’s supernormal growth rate. Read further sections to decode further factors involved!

What drives supernormal growth in stocks?

There are various factors of supernormal growth stock and we have listed some of these below.

1. A surge in demand 

Sometimes, a company experiences a rapid surge in product or service demand. This high demand often leads to increased sales, which in turn increases the company’s profits. From an investor’s point of view, this company would have a high growth potential and, therefore, may experience supernormal growth.

For example,  InfoTech Innovations, an Indian company, experienced a supernormal growth rate during the COVID-19 pandemic when people began using its cloud-based software for video calls and content sharing due to work-from-home policies.

However, after the pandemic receded, its growth rate returned to normal levels. 

2. Groundbreaking innovation

Suppose a company creates an innovative product or service or even launches a creative and compelling market strategy. In that case, the results of these endeavours are reflected in the supernormal growth of the company’s stocks. 

This could be because the company’s success may trigger a surge in demand, leading to the company occupying a larger market share. 

3. Technological advancements

Technological advancements are another factor that may drive a company’s supernormal growth phase. This could be because these advances improve the company’s operations and may provide a competitive edge. 

This was mainly observed when companies developed products based on Artificial Intelligence (AI) before AI technologies became mainstream. 

4. Temporary lead in the market

Supernormal growth can also be prompted if the company experiences the benefits of the first movers’ advantage. Additionally, the company may have obtained a recent patent on its product or process, providing it with a temporary lead in the market.  

This way, the company experiences a supernormal growth phase until its competitors catch up with its technology and quality. 

Supernormal growth stock valuation

The valuation of supernormal growth stocks can be challenging because, unlike normal stocks, they do not experience a steady growth rate. For normal stocks, the Gordon Growth Model or Dividend Discount Model are usually employed to calculate the stock’s intrinsic value.

The supernormal growth stock’s intrinsic value is determined by the supernormal and average growth phases. Therefore, a multi-stage dividend discount model is utilised to estimate its intrinsic value accurately. 

In this model, both higher and average dividends are discounted instead of just discounting the average dividend. However, it is essential to note that an abrupt transition between these phases may mean that the above-stated model may not be the most accurate estimation.

Risks associated with supernormal growth stocks

In financial markets, risk and reward often maintain a proportional relationship. Since supernormal growth stocks offer higher returns, they also have higher risks associated with them. These stocks are likely to be more volatile than average stocks and, therefore, extremely sensitive to market and economic conditions. 

Factors like competitive pressure, government regulations, and a demand reduction can lead to a crash in the stock’s value. Therefore, it is important to maintain caution while deciding to exploit this opportunity.

Conclusion

In summary, a supernormal growth rate provides a lucrative opportunity to you because of their higher-than-average returns. However, they also carry heightened levels of risk. Therefore, it is advisable to carefully evaluate your risk profile and determine whether these stocks are the right investment options for you.

Closely monitor these stocks because, owing to their high price volatility, their prices might fluctuate heavily in either direction! To learn more, stay tuned to StockGro.

FAQs