Here are some of the main types of top Canadian growth stocks—and how to assess which ones offer you the best prospects

Successful Investors know the value of high-performing growth stocks and the potential boost they give to long-term portfolio returns.

Although these stocks can be volatile, the top Canadian growth stocks often make good long-term investments. They may be well-known stars or quiet gems, but they do share one common attribute—they have grown at higher-than-average rates within their industries, or within the market, as a whole, for years or decades.

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Here are three types of top Canadian growth stocks

A few categories of stocks have historically shown strong growth potential. All of them involve heightened risk, but attractive growth prospects:

Small-cap Stocks: There is no universal definition for a “small cap” company compared to a micro-, mid- or large-cap company. Many analysts, however, consider any company with a market capitalization of between $250 million and $1.2 billion to be a small-cap firm.

Companies in this category are often still in their initial phase of growth. Their stocks have the potential to increase significantly. Small-cap stocks have historically posted higher returns than blue-chip stocks, but they are generally more volatile. They also carry a higher degree of risk. But small-cap stocks have frequently outperformed large-cap stocks during periods of recovery from a recession.

Technology and healthcare stocks: Investors looking for a growth stock with strong potential often look for companies that develop new technologies or offer innovations in healthcare. The stocks of companies that develop popular or revolutionary products can rise sharply in price over a relatively short period of time.

Speculative investments: Aggressive investors frequently look to high-risk growth investments such as penny stocks, futures and options contracts, foreign currency and real estate deals that involve undeveloped land. Those who make winning decisions here can earn a return that is many times their initial investment. But they are more likely to lose a lot or even all of their principal.

Two factors that will help you select the top Canadian growth stocks

1. Know the difference between momentum stocks and growth stocks: It’s very easy to confuse growth stocks with momentum stocks. Like growth stocks, momentum stocks often move up faster than the market average. But momentum stocks attract a different kind of investor. Growth-stock investors are in it for the long haul, while momentum investors aim to profit from short-term trades. Momentum investors are particularly keen to jump in on a so-called “positive earnings surprise.” That’s when a company outdoes brokers’ earnings estimates.
2. Add value stocks as well to diversify your portfolio: Most successful investors hold some growth stocks and some value stocks at any given time, depending on where they discover the best opportunities.

Value stocks are stocks trading lower than their fundamentals suggest. They are perceived as undervalued by investors and have the potential to rise steadily. Some technology stocks, for instance, start out as growth stocks and transition into dividend-paying value stocks.

Together, growth stocks and value stocks can form a winning combination. A growth stock can be a top performer while the company is expanding. However, a single quarter of bad earnings can send it into a deep, though often temporary, slide. Value stocks can test your patience by moving sluggishly for months, if not years. But they can make up for it by rising sharply when investors discover their true value.

Use fundamentals to assess the potential of top Canadian growth stocks to add profits to your portfolio

Fundamentals are essentially a company’s financial numbers. These include its balance sheet, statement of cash flows, and income statement, as well as other qualitative and quantitative measurements that can highlight the health and growth prospects of a company.

Using a stock’s fundamentals is also known as “bottom-up” analysis. Using the bottom-up approach, you focus on understanding what’s going on, rather than trying to predict what happens next.

You could call this descriptive finance. You delve into earnings, dividends, sales, balance sheet structure, competitive advantages and so on. From there, it quickly becomes obvious that there’s an awful lot you don’t know about the risks in the investments you are considering. So, you try to design a portfolio in which the risks offset each other.

Over periods of five years and beyond, top investment honours usually go to members of the bottom-up crowd. That’s partly because bottom-uppers tend to make fewer big mistakes. This lets their gains accumulate. This also leads to longer holding periods, which provide greater tax deferral and lower brokerage costs.

Use our three-part Successful Investor approach to find the best Canadian growth stocks

1. Hold mostly high-quality, dividend-paying stocks.
2. Spread your money out across most if not all of the five main economic sectors: Manufacturing & Industry, Resources & Commodities, Consumer, Finance and Utilities.
3. Downplay or stay out of stocks in the broker/media limelight. 

How much of your portfolio is made up of growth stocks at any given time?