The Growth Investment Strategy
Originally published in The Seville Report March 2019 Issue and modified for this post.
The growth investment strategy makes capital appreciation the focal point. Investors who focus on a growth strategy invest in growth companies, which are companies that are expected to grow at an above average rate when compared to the rest of the market. Like with any investment or investment strategy growth investing comes with risks, more risk than say an income or safety investment strategy.
Investors that adopt a growth investment strategy are putting a company’s revenue growth over everything else, while attempting to gage when the company will create free cash flow for itself.
A young growth company may carry a high amount of debt, issue thousands of new shares per quarter, not pay a dividend, and be years away from reporting a profitable quarter or profitable year, but as long as the company continues to increase market share and revenue, it could be considered a good investment for an investor who prefers growth companies.
Growth investors will ignore standard indicators used by other types of investors. Indicators like the price-to-earnings or price-to-sales ratio, return on equity, or return on assets. While value investors see low price-to-earnings or price-to-sales ratios as a signal of undervalued stocks and high price-to-earnings or price-to-sales ratios as a sign of overvalued stocks, growth investors don’t necessarily share this same train of thought.
Oftentimes growth companies have high P/E ratios or a negative P/E ratio because the company does not make a profit. However, as long as revenue and market share are increasing, a growth investor may consider making an investment in that company.
Growth investors look for companies that have the potential for sustained growth in the future. This may seem redundant to the first point that growth investing puts revenue growth over everything but it is not. Often there are companies that enter the markets and are growth companies from the start, think Amazon or Netflix in their early stages. Those two companies made users and/or subscribers their main mission, which created substantial revenue growth. Then there are companies that come into something new and experience a new cycle of growth, think Apple after the release of the iPod and then again with the release of the iPhone. Investors who recognized the potential for sustained revenue growth upon the release of the iPod and the iPhone were handsomely rewarded in the End.
Identifying Growth Companies
Growth investors evaluate a company’s position in its industry to determine if a company has a competitive advantage within its industry?
Growth investors also consider forward earnings and management’s control on cost. Forward earnings will help an investor project future revenues and margins. Also
management’s control of cost can give an investor an ideal of when the company will become profitable.
We’ve mentioned several growth companies already like Amazon, Netflix, and Apple. These are companies that the average person in 2020 should be familiar with. However, successful growth investing sometimes requires investors to take chances on companies that are not household names.
In addition, for a growth investment strategy to pay off investors must be extremely patient. Microsoft and Intel became public companies in the 1980’s and traded for under $5 per share. The revenue and the stock prices of Microsoft and Intel took off in the mid 90s as the demand for computers increased.
Investors who are looking for the next growth opportunity don’t have to spend countless hours looking through Reddit posts and the Wall Street Journal trying to find a diamond in the rough. There are growth opportunities in household names as well. Companies like Amazon and Netflix are still viewed by investors as growth companies, and have continued to grow and reward investors with increasing share prices over the past several years.
Other Ways to Find Growth
Though we’ve only mentioned companies and stocks up to this point there are other options to capture growth. There are Exchange Traded Funds (ETF) that specialize in
growth. The benefit of an ETF is it gives an investor exposure to many different growth opportunities.
An investor can also find growth opportunities in emerging markets, think China 20
years ago. Investors who are confident in their ability to isolate growth companies can invest in specific companies of growing industries within emerging markets. The other option is to use ETFs that concentrate on a specific emerging market.
Keys to Growth Investing
If growth investing sounds like the strategy for you, first, seek out companies that have the potential to grow revenue and earnings per share at an above average rate. You
should not be constrained by value indicators. Good growth companies have a leg up on the rest of their industry and have products, services, or cache that aren’t easy to replicate. Good growth companies also have strong managers with strong visions who can get the most out of what the company is doing.
If singling out a specific stock seems like too much of a headache, there are growth focused ETFs that will provide exposure to growth companies and growth markets.
If you want to learn more about growth investing from a few stock market legends, then check out the following books. T Rowe Price Jr.’ s book/pamphlet Picking Growth Stocks. Thomas Rowe Price Jr. is seen as the father of growth investing. Also, Philip Fisher’s Common Stocks and Uncommon Profits is still one of the most popular books on growth strategy investing. Then there is Peter Lynch, whose investment strategy is a hybrid of growth and value investing. Lynch’s book One Up on Wall Street was a national bestseller, and is definitely worth a read.