Many Wall Street pros would have you believe that growth stock market investing is far more sophisticated than it is. The truth is that anyone can design a portfolio tailored to their own retirement goals by following a consistent approach that honors a few fundamental financial principles like diversification, caution, and long-term thinking.
Growth investing is one of the most popular types available, and we’ll take a full look at the procedures required in implementing this strategy here.
What Is Growth Investing?
Growth investing is a type of investment style and strategy that aims to increase an investor’s money. Growth investors often invest in growth stocks, which are new or tiny businesses whose earnings are predicted to rise at a faster rate than their industry sector or the broader market.
Many investors are drawn to growth investing because investing in rising companies can generate substantial profits (as long as the companies are successful). However, because such businesses are untested, they frequently carry considerable risk.
Growth investing and value investing can be contrasted. Value investing is an investment strategy that entails selecting stocks that appear to be trading at a lower price than their intrinsic or book value.
The Fundamentals of Growth Investing
While some investors seek income from their financial holdings, the majority invest for capital appreciation and growth. One of the most important methods to achieve this goal is through growth investing.
Growth stocks are highly valued because they represent exciting, fresh enterprises in emerging markets and industries. The underlying danger is that growth equities are expensive to buy and hold. Nonetheless, tenacious growth investors just perceive the increased premium as the cost of admission for future growth for years to come.
Another danger to consider: Because growth businesses are more likely to reinvest earnings to expand the business and stimulate more expansion, growth stocks often do not pay dividends, at least not until growth slows.
As a result, growth investing may not be suitable for the risk-averse investor seeking quick profits. On the other hand, growth investing may be better suited to those with larger risk tolerance and a longer investment horizon.
What characteristics distinguish a solid growth stock?
To turn growth investing into a long-term strategy, investors must learn how to discover firms with the greatest potential to become growth stocks. While this is not an entire list, here are three key characteristics for identifying good growth stocks:
#1. Look for new, fast-growing industries:
The first step is to look for fresh industries and sectors that are growing faster than average. Clearly, identifying growth categories and then investing in each early-stage firm that comes along is insufficient. It’s also critical to perform your research on what each company is doing and how they fit into their sector.
#2. Evaluate a company’s future earnings power:
Another crucial factor to evaluate is a company’s ability to make profits in the long run. One can accomplish this by looking at its return on assets (ROA), return on equity (ROE), and current revenues, assets, and profits.
#3. Assess the quality of senior management:
Of course, looking at a company’s sector and current financials isn’t enough. If you want to know whether it will be able to grow sustainably in the future, you should look at the quality of its top management. This entails scrutinizing its board of directors and management, as well as their experience and track record. If there is no one in senior management with significant expertise, it may be dangerous to expect the company to operate strongly and sustainably.
The Impact of Growth Funds
Aside from looking for start-ups and emerging markets, one temptation may be to hunt for initial public offerings to uncover prospective growth stocks. Such IPOs are typically held by companies in high-growth industries and may offer above-average returns.
However, research reveals that IPOs aren’t as profitable as many people believe. Historical data collected by the University of Florida’s Jay Ritter reveals that roughly 60% of IPOs had negative returns for the five years following their initial public offering.
In the face of such risks, one safer choice may be to invest in a mutual fund or ETF that tracks growth equities and sectors and has a diverse portfolio of companies.
Among the most popular growth ETFs are:
- The iShares Russell 1000 Growth ETF is a mutual fund that invests in the Russell 1000 index.
- The Invesco QQQ ETF
- Vanguard Information Technology ETF
- Global Internet Giants ETF (O’Shares)
The iShares Russell 1000 Growth ETF, for example, invests in 500 of the best-performing big U.S. stocks. It returned 37.2 percent in the 12 months to September 2020, compared to 13 percent and 6.6 percent for the S&P 500 and Dow Jones, respectively. However, the NASDAQ grew 45.8 percent during the same time period, implying that not all high-growth funds are more profitable than just investing in a fund that tracks an index.
Similarly, here is a short sample of the most well-known and best-performing growth mutual funds:
- Fidelity Trend Fund
- Zevenbergen Growth Fund
- Blue Chip Growth Fund of T. Rowe Price
- Franklin DynaTech Fund
Value Investing vs. Growth Investing
Appreciation-oriented investors employ both growth and value investing strategies. On the other hand, growth investing is the polar opposite of value investing in terms of strategy.
Both desire a high rate of return on investment. However, while value investing seeks out companies that are underpriced relative to their fundamental worth, growth investing is all about investing in promising companies that have a higher potential for growth.
Stocks are frequently classified as “growth” or “value.” The distinction between growth and value stocks is rather easy and is usually based not just on rates of return, but also on prices.
Value stocks have lower price-to-earnings ratios than growth stocks, which evaluate the ratio of a company’s stock price to earnings per share. Given that the typical P/E ratio for the S&P 500 has traditionally been in that range, anything less than 13 to 15 is regarded as relatively cheap.
When investing in a value stock, an investor stands less of a danger of a significant price drop if a company underperforms or is met with unfavorable news. There may also be more room for its price to rise.
The efficient market hypothesis, on the other hand, maintains that cheap-but-good stocks should be few and far between, or should exist only for a limited period of time before the market ultimately corrects itself.
This is why it’s critical to blend value and growth investing because no strategy can guarantee outsized returns on its own.
Example of a Growth Investing
Amazon Inc. (AMZN) has long been regarded as a high-growth stock. It is still one of the world’s largest firms in 2021, as it has been for some time. Amazon is one of the top three U.S. stocks in terms of market value as of Q1 2021.
Historically, Amazon’s stock has traded at a high price-to-earnings (P/E) ratio. Between 2019 and early 2020, the stock’s P/E ratio remained in the 70s, before falling to roughly 60 in 2021. Despite the company’s size, earnings per share (EPS) growth expectations for the next five years remain in the low 30s.
Investors are ready to invest when there is a prediction for a company to grow (even if the P/E ratio is high). This is because, in hindsight, the current stock price may appear cheap several years from now. The risk is that growth will not continue as planned. Investors paid a hefty price for something they did not obtain. In such instances, the price of a growth stock can plummet substantially.
Tips on Growth Investing
There is no assurance that you will continuously make a profit with growth investing, but there are a few actions you can do to improve your chances.
#1. Diversify:
Diversification is an important strategy in growth investing, just as it is in general investment. A well-balanced and well-maintained stock portfolio will maximize your exposure to reward while reducing your risk exposure. When investing in growth, investors should have a diverse exposure across firms, industries, size, and liquidity. Investors should consider the position size of these holdings since they can add risk to the overall portfolio in a disproportional way.
#2. Go global:
A savvy growth investor considers investing in foreign and emerging markets and distributing capital across a variety of asset types other than shares. Investors should maintain a balance of domestic and overseas investments, as well as other assets such as fixed income and cash, which can provide ballast when volatility strikes and risk assets such as equities fall in value.
#3. Look for the possibility for market dominance:
The tech industry is one area where growth stocks dominate. The fundamental reason for this is that the technology industry virtually always generates disruptive goods that allow their producers to gain market domination. Growth companies generally trade at a valuation premium to the market for a variety of reasons, including greater profit growth, a distinct product or business model, or dominance in their industry.
#4. Choose a decent fund and be patient:
Diversification is vital, but few of us have the time or money to hand-pick hundreds of stocks. As a result, the most effective approach to diversify is usually through an ETF or mutual fund. It’s vital to remember, though, that after you’ve found a decent fund, you’ll need to be patient. Most of the top-performing growth investing stock have strong medium and long-term returns, but you may have to wait at least a year or two before you see a considerable upside. This is especially true for growth investing, considering that some renowned growth businesses (e.g., Amazon) need years before turning a profit.
#5. Research, research, and more research
If you want to know what to expect from growth investing, you must conduct extensive research. This entails analyzing the fundamentals of every firm in which you intend to invest and keeping an eye on the broader economy for evidence of a good climate for growth investing (e.g., low-interest rates). This latter point is critical. When specific economic conditions are satisfied, growth stocks may be more likely to rise or fall, with low interest rates. For example, is an essential indicator of a broader desire for equities.
In conclusion
Growth investing is a complicated topic that is frequently intertwined with other topics such as fundamental analysis, technical analysis, and market research. Individual and institutional investors employ a plethora of other growth strategies, and a comprehensive list is much beyond the scope of this article. Consult your broker or financial advisor for further information on investment growth strategies.
Growth Investing FAQ’s
Who is the father of growth investing?
Benjamin Graham is known as the “Father of Value Investing,” but his greatest financial success came from a single growth stock, which raised his net worth more than all of his previous investments combined.
Is growth investing high risk?
Growth stocks are riskier than shares in more stable, slow-growing corporations.
What is a good long-term growth rate?
The average expected long-term growth rate is 11 percent, with a range of 5 to 20 percent.
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