What is Growth Investing?
Growth investing involves buying and holding stocks of companies expected to grow earnings and revenue at rates exceeding the broader market. Growth investors prioritize fast-expanding companies and emerging industries with significant growth runways over the long-term.
Growth stocks tend to reinvest profits to accelerate expansion rather than pay dividends. They optimize for capital appreciation rather than income. Growth investors accept higher volatility in exchange for potentially superior compounded portfolio growth over time compared to value strategies.
While more aggressive, growth investing still differs from speculation by focusing on company fundamentals and multi-year holding periods rather than short-term trading. However, prudent risk management remains essential given growth stocks’ amplified volatility.
The Growth Investing Framework
Growth investors analyze stocks across four key factors:
Growth Metrics – Earnings, revenue, profit growth compared to peers and the market. Fast consistent growth is ideal.
Competitive Advantages – Network effects, intellectual property, brand power, scale, switching costs and other barriers to entry that strengthen a company’s position.
Financial Health – Strong cash flows, manageable debt levels, high returns on capital enabling reinvestment into growth.
Valuation – Growth prospects must compensate for higher valuations based on ratios like P/E, P/S, PEG ratio compared to industry.
Growth investors must balance upside potential with risks of overpaying for expected growth that fails to materialize. Patience during drawdowns allows compounding to work its magic.
Screening for Top Growth Stocks
Investors can screen for top growth stocks by searching for:
- High Earnings Growth – Look for earnings per share growth exceeding 15-20% annually. The higher the better.
- Rising Profit Margins – Expanding profit margins indicate scalability and pricing power.
- Strong Growth in Revenue – Top line growth over 15% annually signals fast expansion.
- High Return on Equity – Over 15% ROE indicates efficient capital allocation.
- Low PEG Ratio – PEG accounts for valuation relative to earnings growth. Lower is better.
- High Institutional Ownership – Institutions have resources for deep research. Over 50% ownership is ideal.
Where Do Growth Stocks Come From?
The fastest growth companies often emerge from disruptive and transformative secular trends reshaping the business landscape. Growth investors must spot these paradigm shifts early. Some current trends spawning growth leaders include:
- Cloud Computing – Migration to the cloud favors companies like AWS, Microsoft and Google with economies of scale.
- E-Commerce – Online retail disruption has boosted Shopify, Amazon, Etsy, eBay and more.
- Digital Payments – Growing preference for electronic payments benefits networks like Visa and PayPal.
- Video Streaming – Cord-cutting and the move to internet TV aid Netflix, YouTube, Roku.
- Genomics – Advances in genomic medicine and analysis help innovators such as Illumina and Thermo Fisher.
- Artificial Intelligence – Expanding AI capabilities boost NVIDIA, Microsoft, Google and IBM.
- Remote Work – Distributed teams enable Zoom, Slack, DocuSign and cloud providers.
Spotting seismic shifts early allows growth investors to ride winners long before they dominate an industry.
Growth Investing vs. Value Investing
While both target capital appreciation, growth and value investing diverge on key factors:
Metrics – Growth focuses on earnings, revenue, growth metrics. Value prioritizes valuation ratios like P/E, P/B.
Position – Growth favors emerging leaders disrupting industries. Value prefers established players trading below intrinsic value.
Risks – Growth court’s higher volatility. Value aims to mitigate risks via low valuations.
Holding Periods – Growth requires patience to allow expansion stories to play out. Value invests when margins of safety are high.
Mistake Avoidance – Overpaying for growth is hazardous. Value avoids overpaying via strict valuation.
Psychology – Growth requires faith in growth narratives. Value demands emotional detachment from market prices.
Investors should stick to styles suiting their risk tolerance, psychology, and analytical strengths.
Optimizing a Growth Investing Strategy
Growth investors can boost returns and manage risks by:
- Maintaining a long-term investing time horizon of 5-10+ years.
- Diversifying across industries and growth themes to mitigate company-specific risks.
- Reinvesting dividends and capital gains to compound returns.
- Using dollar cost averaging to enter positions rather than market timing.
- Holding through drawdowns assuming fundamentals remain positive.
- Setting stop losses to protect against unexpected events or failed narratives.
- Keeping position sizes small, averaging up over time.
- Avoiding excessive margin use that amplifies volatility.
- Rebalancing to maintain target asset and stock allocations.
Combining patience and prudent risk management allows growth compounding to work its magic long-term.
Evaluating Growth Stocks for Long-Term Potential
When analyzing growth stocks, investors should assess:
Market Opportunity – How big is the untapped market? What shifts make this opportunity viable now? How durable is this opportunity?
Competitive Position – Does the company have quantifiable competitive advantages? How does it compare versus rivals on cost, scale, brand, technology and other factors?
Management – Does the leadership team have the vision, experience, and execution capabilities to capitalize on the opportunity? Significant insider ownership is a positive.
Financial Strength – Does the balance sheet and free cash flow support growth plans? Can growth be self-funded or will dilution from stock issuances be required?
Valuation – Do assumptions justify higher valuations? Consider total addressable market, market share, margins, reinvestment rates, and discount rates.
Macroeconomic Conditions – Will the growth story thrive across business cycles? How vulnerable is it to higher rates and input cost inflation?
Assessing long-term earnings power and resilience provides confidence to endure inevitable volatility bumps.
Key Risks and Mitigants for Growth Investors
While offering substantial upside, growth investing harbors major risks to manage:
Overpaying For Growth – Mitigate by demanding clear value commensuration, focusing on higher quality companies, and avoiding sky-high multiples.
Growth Slowdown – Look for durable long-runways, diversify across multiple growth stories, and watch for peaking growth signals.
Loss Of Competitive Edge – Favor wide moats and continuous reinvestment in maintaining advantages against disruption.
Low or No Profitability – Ensure a viable path to profitability on a forward basis even if current margins are slim.
Overleveraged Balance Sheets – Seek companies that can self-fund growth and are not overly dependent on debt financing.
Macroeconomic Shocks – Growth suffers more during recessions. Diversify across defensive and cyclical growth stocks.
While higher risk, prudent growth investing still offers a viable path to earn superior long-term returns.
Implementing a Growth Investment Strategy
Growth investors have several implementation options:
- Individual Growth Stocks – Build a portfolio of select growth stocks based on bottoms-up research. High maintenance but highest potential upside.
- Growth ETFs – Funds like VUG and IVW provide diversified growth exposure. Useful core holding.
- Growth Mutual Funds – Actively managed growth funds like VIGAX and PRGFX. Higher expense ratios than ETFs.
- Growth Index Funds – Low-cost options like VIGAX and FLPSX track growth benchmarks. Combine with ETFs for broad exposure.
- Thematic Growth ETFs – Target specific high growth themes like technology, biotech, AI, e-commerce.
Diversifying across these options balances costs, diversification benefits, and research intensity.
To Recap
Growth investing requires patience and resilience, but rewards investors who identify emerging winners early and hold through temporary setbacks. Its higher risks are compensated for by potentially market-beating compounded portfolio growth over the long-term.
Blending growth and value strategies enhances diversification. But investors with sufficiently long time horizons and temperaments accepting of volatility can benefit from tilting portfolios toward disciplined growth investing approaches.
Frequently Asked Questions
Q: What growth rate is considered high growth for a stock?
A: Earnings growth over 15-20% annually is generally considered a high growth rate. Revenue growth over 15% also flags a rapid expansion story. But higher growth rates over 50-100% are possible in some cases.
Q: What sectors tend to have the most growth stocks?
A: Technology, consumer discretionary, communication services and healthcare are sectors where high growth stocks proliferate due to transformative trends reshaping these industries.
Q: How long should you hold growth stocks?
A: Growth stocks should generally be held for long time periods of 5-10+ years. This allows their expansion stories time to play out and compounding to build wealth appreciably.
Q: Should I choose individual growth stocks or growth funds?
A: For most investors, a blended approach using growth ETFs and mutual funds as core holdings supplemented by a few individual growth stocks based on high conviction is prudent for diversification.
Q: How can I predict future growth rates and trends?
A: Assessing long-term market size potential, competitive dynamics, cash flow reinvestment rates, historical growth trajectory, and macroeconomic conditions provides a framework for projecting growth. But forecasting is inherently challenging.
Q: What are examples of top growth stocks?
A: Historically top-performing growth stocks include Amazon, Apple, Microsoft, Alphabet, Facebook, Netflix, Nvidia, Adobe, Salesforce, Costco, Mastercard, Visa, Home Depot, and Disney among others.
Q: Should I buy growth stocks at any valuation?
A: No, the higher growth projections must justify higher valuations. Use DCF analysis and ratios like PEG, P/FCF, P/S to ensure you are not overpaying relative to realistic growth assumptions.
Q: How does monetary policy impact growth stocks?
A: Rising interest rates put more pressure on high valuation growth stocks, lowering their relative attractiveness versus value stocks. However, this provides opportunities to buy top growth names at discounts.
In another related article, What is a Growth Fund?
