Growth Investing – A Short Explanation

by ABC

catching-air

[Two common philosophies of stock investing are "value investing" and "growth investing" - value investing is covered in another post]

Growth investing is a strategy by which an investor buys stocks that are forecast to grow at rates exceeding that of its peers or the overall stock market. Growth investors do so by identifying companies that have a special market niche or a new technology which changes the rules of the playing field significantly. Google and Apple are good examples of high-growth companies as their earnings almost inevitably exceed street estimates.

Potential Risks

A large number of today’s large-cap stocks started out as smaller, unknown companies with tremendous growth prospects. Growth investing has special risks and requires that you throw a lot of the basic stock market investing rules out of the window.

You have to fully subscribe to their growth stories, ignore high valuations, count on the best scenarios and be prepared to put up with extreme price volatility. Growth investors believe that earnings momentum will drive the stock price significantly higher and are willing to pay a premium for those stocks that show the promise of rapidly increasing in value.

Smaller high-growth companies tend to outperform their larger peers over the long-term and hugely successful ones are referred to as the five or ten –baggers which is the term used to describe stocks which have increased five to ten times in share price over a length of time, usually three, five or ten years.

However, with high-growth potential comes high expectations and a stock price can be severely punished if a company fails to meet earnings expectations.

How to find growth companies

Of course, you do not need to focus only on high-growth companies; there are also medium-growth companies which fall under the radar but consistently produce excellent results.

You can identify high-growth sectors such as cloud computing or green technology or scour globally for growth opportunities in high-growth economies such as China which has grown at rapid-fire rates from being the world’s low cost manufacturer and is now forecast to lead the global recovery.

However, growth opportunities are not to be found only in “sexy” sectors. Distressed companies on the cusp of a recovery can be a potential growth story, or a well-run restaurant chain with huge lines outside the doors waiting to get in may be your five-bagger pick!

Why should you care what growth investing is?

If you own mutual funds then you might notice that some funds have an investment policy which is slanted towards growth investing or value investing.  This information should be on the company website but could be in the fund name as well ie ABC Growth Fund.  If you weren’t sure what ‘growth investing’ was before then now you know!

Read more about value investing.

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