How does the Growth Investing strategy work?
First and foremost, this strategy focuses on capital appreciation and the company’s future earnings potential. Growth investors typically look for established companies that are likely to grow within an emerging market, or emerging companies that are likely to have high growth in existing markets.
The strategy of growth investing is similar to value investing as investors using these strategies will trawl through a company’s financial statements and deploy their favourite ratios. However, growth investors are assessing the future growth potential of a business, relying on a combination of both subjective and objective measures. They often use the company financials to establish a pattern of revenue, profit growth and forward projections and look at the effectiveness of management, market conditions and competitive pressures.
Growth investors that get it right tend to receive strong returns over the long run, such as those who got into Apple and Microsoft early.
Related article: What are FAANG stocks?
What are growth stocks?
So, what stocks do growth investors gravitate towards? They seek out companies which demonstrate signs of high earnings which are well above average, compared to the industry and the overall market. They also look for stocks that reinvest their earnings rather than pay dividends to investors.
Technology companies and stocks in emerging markets are commonly associated with growth investing. This is because they are often priced higher than their earnings or book value.
Related article: 5 of the Most Common Financial Ratios
Growth Investing Pros:
The potential to generate strong returns
As growth investors actively seek out stocks that are already experiencing rapid growth, which is also expected to continue, it could mean strong returns.
Investors can gain exposure to cutting edge industries
Growth investors are looking for tomorrow’s leaders (the Apple and Amazon of the future), companies that are rapidly evolving and this can be exciting to watch.
Growth Investing Cons:
Growth stocks tend to be volatile
As growth stocks tend to be companies in emerging markets as opposed to established companies, their stock price tends to fluctuate. This can be a little unnerving and not for the faint-hearted. As much as you could potential gain from investing in growth stocks, the risk is heightened and it could also mean great losses.
No dividends
Typically, growth stocks reinvest their earnings and forego paying dividends to their investors. Therefore, if you are looking to generate income from your stocks, the growth investing strategy is unlikely to be a good fit for you.
High Valuation
Investors who are ready to pay a high valuation for a growth stock anticipate the company to show rapid growth for many years to come. The high valuations represent high expectations for the business, therefore often growth stocks sell at a premium.
Take-home message
We’ve only just scratched the surface of growth investing; before applying this strategy be sure to do some thorough research. There are plenty of great online resources and books available for those looking to learn more.
Regardless of the investment strategy that you adopt, the important thing is to have one. A clearly defined investment strategy should allow you to focus on your investment goals and needs.
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