Top 3 ASX Growth Stocks to Watch in Q2

Top 3 ASX Growth Stocks to Watch in Q2

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What is a Growth Stock?

Unlike a value stock—a company trading below value—a growth stock represents a company whose growth rate outpaces or is expected to outpace a broader market average: Australia’s ASX 200 share market index, for example.

Growth companies can surpass the market average and deliver a high earnings multiple (high price-to-earnings [P/E] ratios), which is calculated by dividing the market value per share (the stock’s share price) by the stock’s EPS (earnings per share). This tells the investor how much they pay for each dollar of earnings. So, if a stock trades at A$10 and the EPS is A$1.50 per share, the P/E ratio is 6.6 ≈ 6.7 (10 / 1.5). For those seeking (or relying on) income, growth companies generally do not distribute dividends (if they do, dividends tend to be small). Retained earnings are often reinvested back into the company to fuel further growth.

According to Refinitiv, the P/E ratio for the ASX 200 is 12.21. While P/E ratios vary across the equities space, many consider that growth stocks operate with a P/E ratio greater than 25. Investors, therefore, pay a premium for future growth potential with growth companies. However, this is only one of the many metrics used to value a company’s stock.

Growth stocks generally reflect specialised companies in a niche business area. Many large technology companies fall under the umbrella of growth stocks—think Apple (AAPL), Amazon (AMZN), META Platforms Inc. (META), Microsoft (MSFT) and Alphabet (GOOGL), for example—which are some of the most heavily weighted companies in the Nasdaq 100 (houses approximately 100 of the largest non-financial companies listed on the Nasdaq Stock Exchange which lists more than 3,000 stocks and is the largest electronic securities market in the US).

What is the ASX?

The ASX, or Australian Securities Exchange, is Australia's primary securities exchange and is among the world's leading exchanges in terms of market capitalisation. As of writing, more than 2,300 companies are listed on the ASX, categorised across 11 key sectors, such as consumer discretionary (cyclical) and consumer staples as well as healthcare (defensive). With FP Markets, a globally leading Forex and CFD brokerage, traders can invest across all ASX stocks through CFDs (Contracts for Differences).

Benefits of Investing in Growth Stocks

The potential for higher returns through capital gains is a key benefit of investing in growth stocks. Investors can also hedge against inflation through growth companies. Their growth can outpace inflation, which has increased globally in recent years.

Risks of Investing in Growth Stocks

Absent dividend income, growth investors rely on capital gains. While some growth companies produce market-beating returns, some will fail. Certain companies fall short of producing the targeted growth level, which is a key (and obvious) risk growth investors face, resulting in losses. This is the reason behind adopting a clear risk-management approach and ensuring one’s portfolio is diversified: spreading your investments across different sectors and asset classes.

3 ASX Growth Stocks to Watch in Q2

1. Xero Ltd. (ASX: XRO)

Xero Ltd. boasts a global presence, with offices in Australia, New Zealand, the United Kingdom, and many more countries. The company’s core operation is centred on online business solutions for small businesses.

Trading at A$91.87, Xero has rallied an eye-popping 31%, year to date, reclaiming a sizeable portion of the 50% fall in 2022 (compare this to the broader market YTD gain from the ASX 200 [XJO] at 4.6%). According to the company’s interim report FY23, EBITDA increased more than 10% to A$108.6 million. New subscribers increased by nearly 500,000, accounting for a 16% increase, and revenue grew to A$658.5 million, up 30% in H1 FY23.

According to analysts, revenue and its per-share earnings are anticipated to grow in the coming years. From a technical perspective, the stock pushed back above its 200-day simple moving average in early March this year and chalked up a decisive higher high at A$85.50 on 3 February. Therefore, the stock shows signs of an early trend reversal to the upside.

2. Altium Limited (ASX: ALU)

Altium Limited is an Australian-based multinational software organisation that primarily develops and sells computer software. The company’s share price has rallied nearly 10% (year to date) and is currently trading just north of A$38.43, a rise comfortably exceeding the broader market YTD average gain of 4.6% (ASX 200 [XJO]). The current P/E ratio is at 54.4, far beyond the market average of 12.21, with a peer average of 60.8.

Regarding the financials, revenue (from ordinary activities) jumped 22.5% to $US220.8 million in FY22, up from $US180.2 million in FY21. Profit after income tax (PAT) also soared nearly 60.0% to $US55.5 million in FY22, up from $US35.3 million in FY21. According to analysts, the growth prospects for this company are strong.

Since the mid-June (2022) low at A$24.32, the stock has rallied nearly 14% and is trending higher, visible not only through price crossing above the 200-day simple moving average but also through price structure: a series of higher highs and higher lows. You may also acknowledge that since November 2022, price action has been working between an ascending channel between A$32.90 and A$39.95. The chart studies, therefore, suggest further upside in the direction of the A$45.30 December 2021 peak.

3. Leo Lithium Limited (ASX: LLL)

Established in 2021, Leo Lithium Limited is an Australian-based business specialising in mining and metals. Year to date, LLL is 7.2% higher at a share price of A$0.510, currently exceeding the YTD market average gain of 4.6% (ASX 200 [XJO]). However, the company’s P/E ratio sits at 10.1, which is a touch under the market average of 12.21, with a peer average of around 15.0.

According to analysts’ forecasts, the company’s per-share earnings are poised to increase in the coming years and return on equity (ROE) is also expected to grow.

As evident from the daily chart below, the share price recently overthrew its 50-day simple moving average and is retesting the dynamic value to potentially form support at the time of writing. Technically, the trend remains indecisive at this early juncture of the company. However, if price movement remains around the 50-day SMA and chalks up a fresh higher high (beyond the A$0.565 high), the stock could challenge the A$0.675 top formed in late January of this year.

Charts courtesy of TradingView