Growth investing is a type of investment strategy
Here is how to recognize the best growth investment stocks and how to execute this investment strategy
By Guy Avtalyon
Growth investing is an investment strategy which investors use to find stocks with higher earnings growth prospects. It doesn’t matter how high their prices are. These stocks usually have low dividend yields. Also, they have higher volatility and limited downside protection. Moreover, they are highly sensitive to changes in interest rates. The companies with stocks that trade at high valuation levels usually have a high P/E ratio, high P/B, and P/S ratio.
Growth investing is focused on capital appreciation. Growth investors invest only in companies that have above-median growth. Even if the stock price looks expensive and metrics like price-to-earnings or price-to-book ratios, confirm that. The growth investing strategy is in contrast with value investing.
This investing strategy’s focus is on a company that has a track record of high or rising growth. For example, a company has a stock price that has rise year after year over 3 or 4 years. Such stock is a target of growth investors. But the timeline shouldn’t be so long. Even if a stock rise at price every week for 3 weeks in a row growth investors will be interested in that stock.
Growth investing doesn’t consider direct research or fundamentals only. Very often it may be a response to the market sentiment.
For example, if you drive BMW and your friends also drive a BMW car. And say, the stock has gone up every month for the last six months. Then you know that the overall market sentiment is good. And the sentiment of the consumers is also a good and valuable metric for growth investors.
So, you would buy BMW stock if you support the growth investing viewpoint.
Who are growth investors?
Some famous investors such as Warren Buffett have stated that there is no theoretical difference between the concepts of value and growth (“Growth and Value Investing are joined at the hip”).
That’s because the growth is always a component in the calculation of value. It is constituting a variable whose importance can range from a little too vast. And whose impact can be both negative as well as positive?
Buffet’s opinion in one sentence is: “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price”.
But the real father of growth investing is Thomas Rowe Price, Jr. who worked and promoted growth investing through his company T. Rowe Price. He founded this company in 1937 and today is a publicly-traded multinational investment firm.
How to execute a growth investment strategy?
The following businesses are suitable for growth investing:
- Emerging markets
- Recovery shares
- Blue chips
- Internet and technology stock
- Smaller companies
- Special Situations
What is the main issue with growth investing? It is the fear you are buying at the top of the growth curve. One way to avoid this is to look for long-term growth patterns.
Don’t look at growth surges that last one week, or one month or several months. If you really found a solid company, it should have a history of solid growth. And be able to demonstrate an upward trend in their share price over many years.
But, Most investors do not relly on growth investing alone. They look at other indicators that can support a pattern for future growth. Let’s take the BMW as an example again.
If they are bringing out new lines of the car, expanding to different countries then it is clear that BMW is targeting growth as a strategy for the company. So, you may own a good stock if you are using a growth investing strategy.
This strategy is most effective in the long run. It isn’t suitable for short-term investors for obvious reasons. Growth companies need time to grow.
Every investor should ask this question: Why is growth investing?
The possible answer could be because you want a long-term financial stability and wealth accumulation. And you’ll be right.
How to identify stocks for growth investing?
Growth investment involves picking essentially strong stocks. These stocks have a promising future compared to other stocks in their sector and will have an edge in terms of returns in the long-term. While choosing stock for growth investing, it is important to ensure some essential factors such as the revenue model, cash inflow, growth prospects with respect to the economy, the company’s executive board, market, competition, etc. Researching would let you know if a stock suits the growth investing strategy or not. It is easy to get an insight when you study the company’s balance sheets and reading up more about its history, endeavors, and goals from its website or some other sources. Before taking the final call on your growth investment, it is very important to ensure whether the asset fits the criteria of optimal returns.
Here are a few parameters that could be helpful in analyzing whether a stock is a growth stock or not:
Return on Equity: This means the profit-making potential of the company. It is calculated by dividing the net income of the company with the total equity of the shareholders.
Increase in Earning per Share (EPS): An increased EPS ensures better growth prospects. Hence, it is very important for you to analyze if the EPS is increasing or not over the observed time.
Projected Earnings: It gives an insight into the company’s expected growth and can act as a good indicator of growth investment.
What are the picks for growth investing?
Small-Cap Stocks: Companies that lie in the suit of small-cap are those that are in their initial growth stages. This makes them more promising in growth prospects, the affordability of the stocks is higher. This enables you to buy a bigger lot of their shares and make a decent investment.
Technology and Healthcare Stocks: These companies could be a good pick for growth investing. They are a kind of revolutionary innovations, which increases the scope of their growth prospects. The fact they are exceptionally well in the market because they target a wider audience, thus resulting in exponential growth. They stand by the characteristics of growth in the investment.
Speculative Investments: Even speculative stocks could bring in a fortune in terms of growth investing as they come at a higher risk. If you are choosing a speculative investment, make sure to practice caution and invest only your surplus funds with due diligence.
The great influence in shaping this investment style had Phil Fisher, whose 1958 book “Common Stocks and Uncommon Profits” is still today a reference for identifying growth companies and we highly recommend this book.
