Growth Investing: Overview of the Investing Strategy (2024)

What Is Growth Investing?

Growth investing is an investment style and strategy that is focused on increasing an investor's capital. Growth investors typically invest in growth stocks—that is, young or small companies whose earnings are expected to increase at an above-average rate compared to their industry sector or the overall market.

Growth investing is highly attractive to many investors because buying stock in emerging companies can provide impressive returns (as long as the companies are successful). However, such companies are untried, and thus often pose a fairly high risk.

Growth investing may be contrasted with value investing. Value investing is an investment strategy that involves picking stocks that appear to be trading for less than their intrinsic or book value.

key takeaways

  • Growth investing is a stock-buying strategy that looks for companies that are expected to grow at an above-average rate compared to their industry or the broader market.
  • Growth investors tend to favor smaller, younger companies poised to expand and increase profitability potential in the future.
  • Growth investors often look to five key factors when evaluating stocks: historical and future earnings growth; profit margins; returns on equity (ROE); and share price performance.

Understanding Growth Investing

Growth investors typically look for investments in rapidly expanding industries (or even entire markets) where new technologies and services are being developed. Growth investors look for profits through capital appreciation—that is, the gains they'll achieve when they sell their stock (as opposed to dividends they receive while they own it). In fact, most growth-stock companies reinvest their earnings back into the business rather than paying a dividend to their shareholders.

These companies tend to be small, young companies with excellent potential. They may also be companies that have just started trading publicly. The idea is that the company will prosper and expand, and this growth in earnings or revenues will eventually translate into higher stock prices in the future. Growth stocks may therefore trade at a highprice/earnings (P/E) ratio. They may not have earnings at the present moment but are expected to in the future. This is because they may hold patents or have access to technologies that put them ahead of others in their industry. In order to stay ahead of competitors, they reinvest profits to develop even newer technologies, and they seek to secure patents as a way to ensure longer-term growth.

Becauseinvestors seek to maximize their capital gains, growth investing is also known as a capital growth strategy or a capital appreciation strategy.

Evaluating a Company's Potential for Growth

Growth investors look at a company's or a market's potential for growth. There is no absolute formula for evaluating this potential; it requires a degree of individual interpretation, based on objective and subjective factors, plus personal judgment. Growth investors may use certain methods or criteria as a framework for their analysis, but these methods must be applied with a company's particular situation in mind: Specifically, its current position vis-a-vis its past industry performance and historical financial performance.

In general, though, growth investors look at five key factors when selecting companies that may provide capital appreciation. These include:

Strong Historical Earnings Growth

Companies should show a track record of strong earnings growth over the previous five to 10 years. The minimum earnings per share (EPS) growth depends on the size of the company: for example, you might look for growth of at least 5% for companies that are larger than $4 billion, 7% for companies in the $400 million to $4 billion range, and 12% for smaller companies under $400 million. The basic idea is that if the company has displayed good growth in the recent past, it’s likely to continue doing so moving forward.

Strong Forward Earnings Growth

An earnings announcement is an official public statement of a company’s profitability for a specific period—typically a quarter or a year. These announcements are made on specific dates during earnings season and are preceded by earnings estimates issued by equity analysts. It’s these estimates that growth investors pay close attention to as they try to determine which companies are likely to grow at above-average rates compared to the industry.

Strong Profit Margins

A company’s pretax profit margin is calculated by deducting all expenses from sales (except taxes) and dividing by sales. It’s an important metric to consider because a company can have fantastic growth in sales with poor gains in earnings—which could indicate management is not controlling costs and revenues. In general, if a company exceeds its previous five-year average of pretax profit margins—as well as those of its industry—the company may be a good growth candidate.

Strong Return on Equity (ROE)

A company’s return on equity (ROE) measures its profitability by revealing how much profit a company generates with the money shareholders have invested. It’s calculated by dividing net income by shareholder equity. A good rule of thumb is to compare a company’s present ROE to the five-year average ROE of the company and the industry. Stable or increasing ROE indicates that management is doing a good job generating returns from shareholders’ investments and operating the business efficiently.

Strong Stock Performance

In general, if a stock cannot realistically double in five years, it’s probably not a growth stock. Keep in mind, a stock’s price would double in seven years with a growth rate of just 10%. To double in five years, the growth rate must be 15%—something that’s certainly feasible for young companies in rapidly expanding industries.

You can find growth stocks trading on any exchange and in any industrial sector—but you’ll usually find them in the fastest-growing industries.

Growth Investing vs. Value Investing

Some considergrowth investing and value investingto bediametrically opposed approaches. Value investors seek "value stocks" that trade below theirintrinsic value or book value, whereas growth investors—while they do consider a company's fundamental worth—tend to ignore standard indicators that might show the stock to be overvalued.

While value investors look for stocks that are trading for less than their intrinsic value today—bargain-hunting so to speak—growth investors focus on the future potential of a company, with much less emphasis on the present stock price. Unlike value investors, growth investors may buy stock in companies that are trading higher than their intrinsic value with the assumption that the intrinsic value will grow and ultimately exceed current valuations.

Those interested in learning more about the growth investing, value investing, and other financial topics may want to consider enrolling in one of the best investing courses currently available.

Some Growth Investing Gurus

One notable name among growth investors is Thomas Rowe Price, Jr., who is known as the father of growth investing. In 1950, Price set up the T. Rowe Price Growth Stock Fund, the first mutual fund to be offered by his advisory firm, T. Rowe Price Associates. This flagship fund averaged 15% growth annually for 22 years. Today, T. Rowe Price Group is one of the largest financial services firms in the world.

Philip Fisher also has a notable name in the growth investing field. He outlined his growth investment style in his 1958 book Common Stocks and Uncommon Profits, the first of many he authored. Emphasizing the importance of research, especially through networking, it remains one of the most popular growth investing primers today.

Peter Lynch, manager of Fidelity Investments' legendary Magellan Fund, pioneered a hybrid model of growth and value investing, whichis now commonly referred to as "growth at a reasonable price" (GARP) strategy.

Example of a Growth Stock

Amazon Inc. (AMZN) has long been considered a growth stock. In 2021, it remains one of the largest companies in the world and has been for some time. As of Q1 2021, Amazon ranks in the top three U.S. stocks in terms of itsmarket capitalization.

Amazon's stock has historically traded at a high price to earnings (P/E) ratio. Between 2019 and early 2020, the stock's P/E has remained upwards of 70, moderating to around 60 in 2021. Despite the company's size,earnings per share(EPS) growth estimates for the next five years still hover near 30% per year.

When a company is expected to grow, investors remain willing to invest (even at a high P/E ratio). This is because several years down the road the current stock price may look cheap in hindsight. The risk is that growth doesn't continue as expected. Investors have paid a high price expecting one thing, and not getting it. In such cases, a growth stock's price can fall dramatically.

Growth Investing: Overview of the Investing Strategy (2024)

FAQs

Growth Investing: Overview of the Investing Strategy? ›

Growth investing is an investment style and strategy that is focused on increasing an investor's capital. Growth investors typically invest in growth stocks—that is, young or small companies whose earnings are expected to increase at an above-average rate compared to their industry sector or the overall market.

What is the growth investment strategy? ›

Growth investing is the strategy where the prime focus is to increase the investor's capital. In this strategy, the money is placed on stocks of small and new companies whose earnings are expected to grow at a certain level.

Why is growth investing important? ›

Potential for high returns: One of the main advantages of growth investing is the potential for high returns. Companies that are experiencing rapid growth often see their stock prices rise significantly, which can generate significant returns for investors.

What makes growth investing a high risk strategy? ›

The High-Risk Nature of Growth Investing

Volatility in Growth Stocks: Growth stocks are often subject to significant price volatility, as their valuations are influenced by market expectations and sentiment. This volatility can result in rapid price fluctuations, leading to potential losses for investors.

What is value investing vs growth investing strategies? ›

Growth Investing vs. Value Investing. Where growth investing seeks out companies that are growing their revenue, profits or cash flow at a faster-than-average pace, value investing targets older companies priced below their intrinsic value.

What is an example of growth investing? ›

Amazon is considered one of the best-performing, successful growth stocks over the years, as one can tell from the giant online retailer's immense and continuing success over the years.

What are the three major growth strategies? ›

A growth strategy is a long term approach in business that aims specifically at increasing an organisation's market share. Some common growth strategies in business include market penetration, market expansion, product expansion, diversification and acquisition.

Who uses growth investing? ›

Growth investors are effectively value investors sometimes, in that they seek out companies whose stock may be currently undervalued due to reasons that may be as simple as the fact that the company is relatively new and has not yet caught the attention of many investment analysts or fund managers.

What is the best growth strategy for a portfolio? ›

Ways to make your portfolio grow faster include choosing stocks over bonds, investing in small-cap companies, investing in low-fee funds, diversifying your portfolio, and rebalancing your portfolio regularly.

What is the most successful investment strategy? ›

Invest for the long term

Time is on the side of the investor and a buy-and-hold strategy usually produces better results in the long term.

What is the most risky growth strategy? ›

Different combinations of strategies involve varying levels of risk. Market penetration is considered the least risky, because you're working with a known market and existing products. Diversification is the riskiest growth strategy in the grid, involving a leap into the unknown with new markets and new products.

Is value investing safer than growth investing? ›

Value stocks have more limited upside potential and, therefore, can be safer investments than growth stocks.

How do you know if a stock is a growth stock? ›

5 Characteristics of Good Growth Stocks
  1. A Strong Leadership Team. Growth companies focus on increasing their sales and profits. ...
  2. A Promising Growth Industry. ...
  3. Commanding Market Share. ...
  4. Strong Sales Growth. ...
  5. A Large Target Market.

Can a stock be both growth and value? ›

Stocks are always fully represented by the combination of their growth and value weights. For example, a stock that is given a 20% weight in a Russell value index will have an 80% weight in the corresponding Russell growth index.

What is the most common growth strategy? ›

Market Penetration Strategy

One of the most common types of business growth strategies is market penetration. Market penetration occurs when a company increases its presence in an already existing market. There are two types of market penetration strategies: horizontal and vertical.

What is the 3 investment strategy? ›

A three-fund portfolio is a portfolio which uses only basic asset classes — usually a domestic stock "total market" index fund, an international stock "total market" index fund and a bond "total market" index fund.

What are the strategies 4 growth? ›

In the paper, he describes four means of growing an organization that corresponds to the four quadrants of a product-market matrix. The four strategies Ansoff identifies are market penetration, product development, market development, and diversification.

Top Articles
Latest Posts
Recommended Articles
Article information

Author: Trent Wehner

Last Updated:

Views: 5617

Rating: 4.6 / 5 (76 voted)

Reviews: 83% of readers found this page helpful

Author information

Name: Trent Wehner

Birthday: 1993-03-14

Address: 872 Kevin Squares, New Codyville, AK 01785-0416

Phone: +18698800304764

Job: Senior Farming Developer

Hobby: Paintball, Calligraphy, Hunting, Flying disc, Lapidary, Rafting, Inline skating

Introduction: My name is Trent Wehner, I am a talented, brainy, zealous, light, funny, gleaming, attractive person who loves writing and wants to share my knowledge and understanding with you.