What is Growth Investing?
Growth investing is an investment style and strategy focused on increasing an investor’s capital through investing in growth stocks – young or small companies with expected above-average earnings growth compared to their industry sector or the overall market.
Growth investing is highly enticing for investors due to the potential for impressive returns when stocks in emerging companies perform well. However, these companies are often untested, posing higher risks.
This strategy contrasts with value investing, which involves picking stocks trading for less than their intrinsic or book value.
Key Takeaways
- Above-Average Growth: Growth investing seeks companies expected to grow at a higher rate compared to their industry or the market.
- Focus on Emerging Companies: Investors typically favor smaller, younger companies with high future profitability potential.
- Evaluation Criteria: Growth investors look at historical and future earnings growth, profit margins, return on equity (ROE), and share price performance.
Understanding Growth Investing
Growth investors target rapidly expanding industries or markets where new technologies and services are being developed. The focus is on capital appreciation – the gains achieved when selling stock. Many growth-stock companies reinvest earnings into the business rather than paying dividends, aiming to stay ahead of competitors by advancing technologies and securing patents.
Due to the emphasis on capital gains, growth investing is also known as a capital growth or capital appreciation strategy.
Evaluating a Company’s Potential for Growth
Growth investors look at numerous factors to gauge a company’s potential for growth, applying methods with consideration of a company’s unique situation. Key criteria include:
- Strong Historical Earnings Growth: A track record of solid earnings growth over five to ten years. For instance, aiming for at least 5% growth for companies larger than $4 billion.
- Strong Forward Earnings Growth: Growth investors focus on earnings estimates and announcements to identify companies likely to grow at above-average rates.
- Strong Profit Margins: A company’s pre-tax profit margin should significantly exceed industry averages and its own five-year historical average.
- Strong Return on Equity (ROE): Consistent or improving ROE indicates efficient management of shareholder investments.
- Strong Stock Performance: Stocks should have the potential to realistically double in value in five years, requiring an annual growth rate of about 15%.
Growth Investing vs. Value Investing
While value investing focuses on finding undervalued stocks trading below intrinsic value, growth investors emphasize future potential over current value, often ignoring standard indicators of overvaluation.
Notable Growth Investing Gurus
- Thomas Rowe Price, Jr.: Founder of T. Rowe Price Growth Stock Fund, known as the father of growth investing.
- Philip Fisher: Author of Common Stocks and Uncommon Profits, promoting thorough research and networking.
- Peter Lynch: Manager of the Fidelity Magellan Fund, pioneer of the
Related Terms: capital gains, earnings growth, profit margins, dividends, return on equity, stock performance, value investing.
References
- CompaniesMarketCap. “Largest Companies by Market Cap”.
- Yahoo! Finance. “AMZN”.
