Growth stocks tend to outperform when their earnings outperform, which is usually at the beginning and end of most business cycles. Of course, this escalator effect can also work in reverse in broad market declines or when a particular company loses its earnings momentum. Fast-growing companies need a lot of capital to finance their expansion, and most reinvest a high portion or all of their earnings in their own businesses. Emerging growth companies usually pay no dividends, and even large, established growth companies may pay only nominal ones. Therefore, the yield on growth stocks as a group is generally below the market average.
All stocks are vulnerable to changes in investor psychology, but none more so than growth stocks.
First, these companies lack the dividend yield that can cushion stock prices in market downdrafts. Second, and more important, is the role of expectations. These companies are expected to increase their earnings at a certain rate. When these expectations are not met, investors can punish the stocks inordinately even if earnings showed an absolute increase. By the same token, earnings that exceed projections can trigger sharp price gains.