Growth investing is a type of investing that focuses on the price or value of an asset going up over time. People who use this strategy are called growth investors, and they focus more on the future potential of a company than on its price at the moment. Investors often call it “capital growth strategy” because they want to make the most money from their investments.
It will be easier to describe growth investing if we compare it to value investing. Value investors look for stocks that are selling for less than what they are really worth. Growth investors, on the other hand, are more interested in a company’s future potential and pay less attention to its current price. Growth investors try to get richer by putting most of their money into long-term or short-term investments. If you learn about the stock market, you’ll have a better idea of how this type of investment works.
What is actually growth investing?
Growth investors usually look for places to put their money in industries or even whole markets that are growing quickly and where new technologies and services are being introduced. Growth investors try to make money through their stock’s capital appreciation, which is different from the dividends they get while owning the stock. In fact, most companies with growth stocks put their profits back into the business instead of giving their shareholders a dividend.
Most of these companies are small and young, but they have a lot of potential. They could also be companies that have just started trading on the stock market. The idea is that the company will do well and grow, and that this increase in profits or sales will eventually lead to higher stock prices. Because of this, growth stocks may have a high price-to-earnings ratio (P/E).
They may not be making money right now, but they are likely to in the future. This is because they may have patents or access to technologies that put them ahead of others in their industry. So they can stay ahead of their competitors, they put their profits back into developing even newer technologies and trying to get patents as a way to make sure their growth will last for a long time.
The key steps in growth investing strategy
So, now that you’ve determined that growth investing is right for you, let’s take a deeper look at the processes required in completely implementing the plan.
Prepare your assets
As a general rule, you shouldn’t buy stocks with money you think you’ll need within the next five years. Even though the market usually goes up over the long term, it often has sudden drops of 10%, 20%, or even more with no warning. As an investor, one of the worst things you can do is put yourself in a position where you have to sell stocks during one of these down times. Best case scenario, you’ll be ready to buy stocks when most people are selling.
The growth approaches
Now that you’re taking steps to improve your finances, it’s time to give yourself another powerful tool: knowledge. After all, there are different ways to invest for growth that you can choose from.
For example, you can only look at large, well-known businesses that have a track record of making money. Your plan could be based on numbers like operating margin, return on invested capital, and compound annual growth that can be used in stock screeners. On the other hand, many growth investors focus less on share prices and more on buying the best-performing businesses, which can be seen by their steady market share gains.
Most of the time, it makes sense to buy things from industries and companies you know well. Whether it’s because you’ve worked in the restaurant business or for a cloud software services company, your experience will help you figure out which investments might be good buys. Most of the time, it’s better to know a lot about a small group of companies than to know a little about a lot of companies.
The most important thing for your returns, though, is that you stick with the strategy you choose and resist the urge to try something new just because it seems to work better right now. This is called “chasing returns,” and it’s a surefire way to lose money over time compared to the market.
Stock picking
Now is the time to get ready to start investing. The first step in this part of the process is to decide how much money you want to put into your growth investment strategy. If you’ve never done this before, you might want to start with a small amount, like 10% of your portfolio funds. This ratio can go up as you get used to how volatile the market is and as you gain experience investing through different types of markets (rallys, slumps, and everything in between).
Risk is also a big part of this decision, since growth stocks are seen as more risky. This is because they are more aggressive than defensive stocks. Because of this, having a longer time horizon usually gives you more freedom to tilt your portfolio toward this style of investing.
If your portfolio makes you nervous, that’s a good sign that you have too much money in growth stocks. If you’re worried about possible losses or upset about market drops in the past, you might want to invest less in individual growth stocks and more in stocks with a wider range of risks.
Buying growth funds
Through a fund, it’s easy to get exposure to a wide range of growth stocks. Many retirement plans have options that focus on growth, and you could base your investing strategy on these.
If you want to make more self-directed choices, you might want to consider buying a growth-based index fund. Index funds are the best way to invest because they give you diversification and have lower costs than mutual funds. This is because, unlike mutual funds, which are run by investment managers who try to beat the market, index funds use computer algorithms to simply match the return of the industry benchmark. Most investment managers don’t beat that benchmark, so with an index fund you’ll usually come out ahead.
Screening for stocks that will grow
You can buy individual growth stocks if you want to get more involved in doing things yourself. This approach provides the highest chance of outperforming the market, but it’s riskier than diversifying.
To find growth stocks, you can look for things like:
-Above-average rise in earnings per share, or the profits generated by the firm each year.
-Above-average profitability (operational margin or gross margin), or the percentage of revenues turned into profits by a firm.
-High revenue or sales growth in the past.
-High return on invested capital, which measures how well a corporation spends its money.
At the same time, keep an eye out for red signs that indicate a firm is risky. Here are a few examples:
-In the previous three years, the corporation had an annual net loss. Most growth investors won’t be put off by this, but it does indicate that a firm has yet to develop a viable business plan.
-The firm has a little market valuation (for example, less than $500 million). Smaller companies are exposed to larger rivals and a variety of other upheavals that might jeopardize their entire operations. As a result, many investors begin their hunt for companies in the “mid-cap” category.
-A recent management shuffle occurred, notably in the CEO post.
-Sales and/or profitability are decreasing. It will not qualify as a growth stock if its key operating indicators continue to decline.
Maximize returns
Growth stocks tend to be unstable and your goal should be to hold each investment for at least a few years.
However, you should still keep an eye on big price changes for a few important reasons:
-One of your investments has grown so much in value that it makes up most of your portfolio, you might want to rebalance it to reduce your risk.
-If the price of a stock goes up a lot more than you thought it would, you might want to sell it, especially if you’ve found other investments that are more affordable.
-If the company’s tough patch contradicts your investing thesis, you may wish to sell. A broken thesis could be caused by big mistakes made by the management team. Or because of a long-term drop in pricing power, or a lower-priced competitor who messes with the market.
These are just a few of the many reasons why an investor might want to sell a stock to make changes to their portfolio.
Assuming you performed your research before buying stocks, sit back and be patient. Allow compounding returns work their magic on your portfolio over the next 10, 20, 30, or more years.
A growth stock example
Amazon Inc. (AMZN) has been thought of as a growth stock for a long time. It is still one of the biggest companies in the world in 2022, as it has been for a while. As of Q4 2022, Amazon’s market capitalization puts it in the top five U.S. stocks.
Amazon stock has always had a high price-to-earnings ratio (P/E). The stock’s price-to-earnings ratio (P/E) has been above 70 from 2019 to the beginning of 2020. In 2021, it will drop to around 60. Even though the company is big, estimates for growth in earnings per share (EPS) over the next five years still hover around 30% per year.
Even if a company has a high P/E ratio, investors will still put money into it if they think it will grow. This is because in a few years, the current stock price might look like a good deal. There is a chance that growth won’t keep going as planned. Investors have paid a lot of money for something they didn’t get. In this case, the price of a growth stock can drop by a lot.
Bottom line
Investors have numerous alternatives and strategies to implement a capital appreciation plan. This includes investing in blue-chip businesses, investing in smaller companies with strong growth potential, investing in emerging markets, and so on. Warren Buffet, through his business partner Charlie Munger, realized the significance of growth investment, as Buffet stated:
“It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price”
