Growth Investing

Every investor wants to outperform the market and generate significant gains, but there are many ways to potentially reach those goals. Depending on individual risk tolerance, personal goals, management preferences and allocation, investors choose a strategy that fits their unique needs in hopes that it will allow them to find stocks that will help fund their financial objectives. Growth investing is a popular investment strategy that focuses on investing in companies possessing attractive growth characteristics that their rivals in the same industry lack. In this article you’ll learn:

• What sets this investment strategy apart from others,
• The characteristics that are often associated with growth stocks,
• What types of investors can benefit from growth investing and
• The pros and cons of growth investing.

At AAII, we believe that by applying a consistent approach and developing a clear financial plan anyone can build a portfolio to effectively fund their financial goals. However, it’s important to truly understand different types of investing strategies, such as growth investing, to see which one is best suited for your individual needs.

What Is Growth Investing?

Growth investing is a common strategy that focuses on finding high-reward and, often, high-risk stocks that are expected to outperform the overall market and their peers. It’s important to remember that these companies are projected to “beat the market” based on growth metrics or earnings for a specific quarter/year, but that won’t necessarily always be the case.

Additionally, this strategy often involves investing in new, innovative companies including those in emerging markets or those that have something their rivals lack. Common industries where you can find growth stocks are technology and health care.

Growth investing is often contrasted to value investing, which focuses on stocks that have lower valuations than others in their industry. Most companies that are considered growth stocks don’t pay dividends to their shareholders. Instead, they choose to reinvest their earnings back into the company to facilitate growth. This is one important factor to consider when choosing to pursue growth versus value investing strategies.

Types of Growth Investments

If you’re interested in finding growth-oriented securities for your portfolio, you may want to learn about the various types of growth investments that are available. These include:

• Growth funds: These are typically mutual funds that are heavily invested in companies with above-average growth over a certain time frame.
• Growth stocks: Companies that plan to develop revolutionary products for their industry—often in the technology or health care sector—can rise exponentially in price, indicating major growth.
• Small-cap stocks: Companies in this category are often still in their initial phase of growth and their stocks have the potential for substantial price appreciation over time.

No matter which type of growth investment you choose to focus on, you will want to do your due diligence by researching the companies that interest you. It’s important to note that companies classified as a growth investment can easily fall out of this category if their expected earnings are not what investors were hoping for. Growth investment can be a fleeting label, so make sure you have up-to-date information and metrics before deciding which securities to consider.

Learn about other types of marketable securities to see if they fit your allocation and portfolio needs.

How Can You Evaluate a Company’s Growth?

Now that you know which types of growth investments to focus on, you need to learn how you can effectively evaluate a company’s growth to see if it is sustainable or not. It is common for investors and financial analysts to look at bottom-line and top-line growth. Bottom-line growth describes companies that are growing their earnings or reducing their costs of goods/services. Typically, investors will want to look for bottom-line growth of at least 10%.

On the other hand, you’ll also want to consider top-line growth, which looks at a company’s ability to increase revenue through its core business operations. Often, if a company wants to have sustainable bottom-line growth, it must have significant top-line growth as well.

Earnings per share (EPS) and free cash flow per share are two common metrics to start with, but there are numerous other growth metrics you can analyze, such as:

• Return on equity (ROE)
• Return on assets (ROA)
• Profit margins
• Projected earnings

Not only will you want to look at the above metrics, as well as bottom- and top-line growth, but you’ll want to evaluate if the company in question possesses the common qualities of a growth investment. The primary qualities a growth investment should possess are:

• Strong historical earnings growth
• Strong forward earnings growth
• Strong profit margins
• Strong stock performance
• Strong return on equity
• Sustainable competitive advantage
• Quality senior management
• In a new or fast-moving sector
• Future earnings potential
• A good chance for considerable expansion over the next few years

If the growth investment you are interested in pursuing possesses many of the above qualities, then you may want to add it to your watchlist. Of course, before investing in any type of investment, ensure it aligns with your investment goals, allocation needs and risk tolerance. Risk tolerance is more relevant to growth investing since stocks can be risky for those who are in the moderate or conservative risk tolerance bracket.

Lastly, you can use these metrics and qualities and other criteria when screening for growth stocks that may be good additions to your portfolio.

Check out A+ Investor’s Custom Stock Screener to find winning growth stocks today.

Risks and Rewards of Growth Investing

You wouldn’t go skydiving before understanding the potential risks, would you? So why would you jump into an investment strategy without doing the same? Like any type of strategy or group of investments, growth investing carries both risks and rewards. Before deciding if growth investing is the right strategy for you, you’ll want to consider the pros and cons.

Advantages of Growth Investing

Adopting a growth investing strategy has specific advantages that include:

• The ability to generate high capital appreciation, which leads to a faster accumulation of wealth; and
• The ability to acquire capital gains faster than value investing.

One of the primary advantages of growth investing that makes it attractive for investors with an aggressive or moderate risk tolerance is the ability to generate large capital gains. Growth investing can be a profitable ride, and stocks whose shares are expected to grow faster than the overall market can offer investors a way to increase their overall portfolio’s return in a relatively short amount of time. Market volatility is a major influencing factor on growth investments since the higher potential upside comes with a higher risk of downside but also a chance to increase profits compared to other types of investments in the same sector. It’s a chance for investors to find that “diamond in the rough” so they can buy it at a lower price and ride its growth all the way to the top.

The second advantage of investing in growth companies is that you can acquire capital gains quicker than value stocks. Although you may have to endure some risk, if you can weather the storm, you’ll be able to build up your portfolio in a timelier matter than if you chose a different investment strategy.

Disadvantages of Growth Investing

Growth investing can seem like a “no brainer”; why wouldn’t someone want to increase their capital gains in a shorter time frame? But it’s important to understand why growth investing may not be right for everyone. Some disadvantages of growth investing include:

• Growth stocks rarely pay dividends,
• Growth stocks can be relatively risky,
• Investors may only achieve short-term gains,
• These investments require substantial research,
• Some growth stocks and funds may be overpriced compared to value stocks and
• Growth investing is a long-term strategy, not suited for day traders or speculators.

Overall, it’s important to realize that growth investments are appropriate for investors with a long-term time horizon and a moderate to aggressive risk tolerance. Generally, a person nearing or in retirement would not do well with a portfolio heavily weighted toward growth stocks and funds. A well-diversified portfolio can have some growth investments, but it should not have a large allocation to growth if you’re nearing retirement and will have to rely on a fixed income to fund your lifestyle.

The AAII PRISM Academy can help guide you through prioritizing your goals, recognizing your risk tolerance and understanding your allocation needs.

Investing in Growth Investments: The Bottom Line

So, you may be thinking, what do I do now? The bottom line when it comes to growth investing is that it can be a successful long-term play to help you build up your portfolio, but it is not without risk. Always be sure to thoughtfully select your growth investments and do your own research before choosing which securities would be a good fit. Additionally, you’ll want to be prepared to hold growth investments through both bear and bull markets.

Lastly, consider your personal preferences before choosing to invest in growth stocks. Think about what gaps there are in your portfolio, recognize your current risk tolerance and evaluate whether the life stage you’re in aligns well with growth investing.

If you’re interested in learning more about which investment strategy is right for you, we offer a bundled package known as AAII Platinum. AAII Platinum lets you test new strategies in different markets so you can always find a winning strategy that fits your specific needs. For example, Stock Superstars Report, an AAII premium subscription, is included in AAII Platinum. With Stock Superstars Report, you can learn about how to effectively combine a growth strategy with other strategies to build a diversified stock portfolio.

Learn more about AAII Platinum today and find an investment strategy that will help you achieve your financial goals.

Additional Resources About Growth Investing

Looking for educational materials and information about growth investing? We’ve compiled a list of resources you can use to figure out whether growth investing is for you and to elevate your strategy.

• Searching for Future Stock Market Winners
• Methods for Valuing a Stock Based on Profitability and Growth
• William O’Neil’s CAN SLIM Approach to Selecting Growth Stocks Using Fundamental and Technical Data
• Traits to Look for in Growth Stocks
• Methods for Valuing a Stock Based on Profitability and Growth