Growth investing is a strategy that centers on choosing stocks and similar investments that have significant growth potential. A portfolio that’s growth-focused may include stocks, mutual funds, exchange-traded funds (ETFs) and other securities. The goal of growth investing is to generate above-average market returns with those investments. Growth investing is often compared to value investing, which offers a different take on building wealth over the long term. Whether you choose growth or value can depend on your investment style, objectives and risk tolerance.
Consult a financial advisor for valuable advice on how to strike the best balance between growth and value investing.
What Is Growth Investing?
Growth investing is all about finding stocks to invest in that could potentially outpace the market in terms of returns. Investors who follow this strategy are interested in choosing companies that are actively growing and offer the best chance of long-term capital appreciation. In other words, growth investors want to own companies they can sell for a sizable profit later.
Growth companies can include newer companies and or companies that have recently completed an initial public offering (IPO). That’s because these companies have more room to grow and expand compared to older, established companies whose growth has leveled off. But not just any company will fit a growth investing strategy. Growth investors look for stocks that have the best prospects of increasing in value over time.
A growth company or growth stock typically reinvests most or all of its profits into expansion. While some growth companies do pay dividends, that’s less common. You can find growth stocks in virtually every stock market sector, though you may be more likely to come across them in sectors that are highly innovative. Technology and healthcare, for example, are constantly changing and evolving offering opportunities for new companies to claim a share of the market.
Is Growth Investing High Risk?
Applying a growth investing strategy can involve more risk than other investment strategies. When you invest for growth, you’re taking a chance on the companies you hold in your portfolio. Specifically, you’re betting on whether the company’s growth will meet your expectations.
If you’re right and you buy low and sell high you could make a profit with growth investing. If you’re wrong, on the other hand, and the company misses the mark you may end up with a smaller profit than expected or even take a loss on the investment. You could make some income off the investment through dividends but again, dividends are more the exception than the rule with growth stocks.
Growth stocks can also be more susceptible to volatility simply because they’re usually associated with newer companies. While a growth company’s earnings may be increasing at a faster rate than its more established competitors, earnings aren’t always guaranteed. A poor earnings report could turn the tide on investor sentiment toward the stock, causing its price to drop. For that reason, growth investing may be less appealing to investors who have a lower risk tolerance.
When utilizing a growth investing strategy, it’s important to look out for growth traps. A growth trap is a company that appears to have all the characteristics or markers for growth but fails to live up to investor expectations. It’s similar to a value trap in value investing -this is a company that appears to be undervalued but in reality is not. Looking under the hood with fundamental analysis can help you spot growth or value traps so you can avoid these investments if they’re a portfolio mismatch.
What Is a Good Growth Investment?
The first step in applying growth investing strategies is figuring out how to identify stocks that have the best outlook for growth. Measuring a growth stock’s potential means looking for certain indicators, including:
Earnings per share (EPS) growth. Earnings per share is a company’s profit divided by its outstanding shares of common stock. Companies that fit the growth mold tend to see EPS increase at a faster clip than their competitors.
Profitability. Growth companies also tend to report above-average profits compared to their competitors. So you could look at profit margins to see how wide the gap is between revenues from sales and operational costs.
Historical revenue or sales growth. Looking at a company’s last several years of revenue and sales can also be an indicator of growth potential. If a company has been growing at a steady pace year over year that trend may be likely to continue for the foreseeable future.
Good return on equity. Return on equity is a measure of a company’s net income divided by its shareholder equity. This financial ratio can tell you how well the company is doing in terms of generating returns and managing operations.
It’s also important to look for indicators that a stock may not be a good growth fit. For example, if the company is still reporting net losses several years after going public that could be a sign that its business model isn’t on firm ground yet. Or if any of the metrics mentioned above are moving in a negative rather than positive direction, that could suggest the company is shrinking rather than expanding.
Style Differences: Value and Growth
Value investing centers on finding stocks to invest in that are undervalued by the market. The goal as a value investor is to find stocks you can buy low then sell high later once the stock’s true value is reflected by the market. This is the investing strategy popularized by Warren Buffett. In terms of how the styles of value and growth investing compare, value investing is about finding companies that are trading below their intrinsic or book value. So you’re looking for the hidden gems, so to speak, that are trading at what’s effectively a bargain price. With growth investing, the market’s perceived value is less important than the company’s growth potential.
Neither approach is necessarily better than the other; the one you choose depends on your investment style, risk tolerance and objectives. Fundamental analysis can play a part with both strategies as you’re using financial ratios such as earnings per share and price to earnings (P/E) to guide investment decisions. Where they diverge is their focus. Value investors are concerned with a stock’s intrinsic or book value today while growth investors are more concerned with what a stock might be valued at tomorrow.
How to Apply Growth Investing Strategies
If you’re trading growth stocks in an online brokerage account, consider how much of your portfolio you want to allocate to these investments. Remember, growth stocks tend to be higher risk than value stocks or investments in established companies. So your asset allocation to growth should match your tolerance and capacity for risk.
Also, consider the holding period for growth stocks and how long you plan to keep individual companies in your portfolio. At a minimum, you may want to hold onto these stocks for a few years but it’s possible you could hold them much longer if it takes time for a company’s growth to plateau. Rebalancing regularly can help you maintain the right mix of assets as your goals or risk tolerance changes over time.
Finally, consider your exit strategy. Ask yourself at what point it would make sense to sell a growth stock you own. If, for example, the stock’s price surpasses your expectations then you may choose to sell while it’s up on the off chance that the higher price isn’t sustainable. Likewise, you may want to set a baseline for selling the stock if its price falls to a certain point. Talking to your financial advisor can help you develop a growth investing strategy that’s designed to see you through changing life stages.
The Bottom Line
Growth investing is all about finding investments that can deliver above-average returns. While there are no guarantees, investing in growth stocks could be profitable if you’re comfortable with the higher degree of risk it requires you to take on. On the other hand, if you’re more interested in finding bargain stocks that may appreciate over time, a value investing approach could be the better fit.
Tips for Investing
Consider talking to a financial advisor about how to employ a growth investing strategy in your portfolio. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors in your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor, get started now.
Whether you’re a value or growth investor, inflation can be a hidden enemy that you have to stay ahead of. Our inflation calculator helps investors understand how rising costs can impact the buying power of their money over time.
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