Posted On November 17, 2020, 3:26 am by Christina Clarke
What is Growth Investing?
Growth investing refers to a strategy or a style of investment which focuses on enhancing the capital of an investor. The investors in this type of trading generally invest in growth stocks. Growth stocks refer to the share of small or new firms. Anticipated earnings surge at an above-average level compared to the overall market of their industry sector.
Growth investing is highly luring for many traders because purchasing share in developing firms can generate remarkable profits if the firms are successful. However, these companies are relatively new; hence, there is a large level of risk associated with them.
Several points regarding Growth investing
- Growth investors generally monitor the five crucial factors while evaluating stocks. These factors include future and historical earnings growth, share price performance, returns on equity and profit margins.
- Growth investors always try to enhance their capital through short-term or long-term capital appreciation.
- Apart from growth investing, investors also invest in value investing.
Growth investing and value investing are two popular approaches to stock trading. For understanding the stock market better, one requires to go through the concept of growth stocks and value stock. Thus, here in the article, we have presented all the information which you will need to build a strong foundation in growth stocks.
Understanding the term Growth Investing and Growth Stocks
Growth investing and value investing stand in strong contrast with each other. Growth investing is when a trader invests in such companies which are still growing and have huge potential. It requires a lot of research on the trader’s part to find firms that have huge potential and can withstand the competitions with other companies in the same field. Instead of spending in an established firm, the trader takes a risk with the hope that the firm will grow further and will generate profit for him.
Growth stocks are the share of those companies which have high potential to grow at the rate higher than the average market rate. Big firms generally pay all the dividends to their stakeholders, but growth firms usually reinvest their dividends to develop the firm.
These firms are becoming popular for investment because they have shown great potential over time. This potential is the outcome of their advance or unique products which they sell in the market. These items prove to be far better from that of competitor’s items.
Vehicles for growth investing
For executing the growth investing strategy, there are numerous ways. Some of these ways include:
- Special situations
- Internet and technology stock
- Blue chips
- Smaller companies
- Emerging markets
- Recovery shares
Evaluating the Firm’s Potential for Growth
Growth investors generally look at a market’s or firm’s potential for growth. There is no static or fixed formula for calculating this potential. It involves how the individual draws conclusions based on both subjective and objective factors. Growth investors may also employ specific criteria or methods as a framework for carrying out analysis.
However, all these criteria should get applied by keeping the situation of the company in mind mainly its present position, historical financial performance and past industry performance. In general, the investors look into the five key factors while choosing the companies which may give capital appreciation. These factors include:
5 Key Factors for choosing Companies for Growth Investing
Stock historical earnings growth:
Firms should always show the record of their earnings growth over the past five to ten years. The minimum earnings per share growth lie in the size of the firm. For instance, you might go with the growth of at least 4% for firms which are more massive than four billion dollars, 6% for firms between $400 million and $4 billion range and 10% for the smaller firms under the amount $400 million. The basic idea behind this is that the past performance of the company decides whether it will grow further or not.
Strong forward earning growth:
The earnings announcements is an official statement reflecting the profitability of the company for a specific interval (generally a quarter or a year). These statements are released on the particular dates or during earnings season. These are preceded by the company’s earnings estimates (issued by the stock analysts). The growth investors pay more attention to them because these estimates determine which firms are more likely to develop at above-average rates compared to other sectors or industries.
Strong profit margins:
The profit margin of a company is estimated by subtracting all expenses from the sales (excluding taxes) and dividing the result with sales. It is an important point to note because a firm might have excellent growth in sales amid poor gains in earning. It directly reflects that the management of the company is not controlling revenues and cost. In general, if a firm surpasses its last five-year average profit margins (along with those of its industry), then the company is considered a good growth stock.
Strong return on equity:
The firm’s ROE (return on equity) reflects the profitability of the company by showing how much return a company generates with the capital stakeholders have spent. It is estimated by divings the overall income by the stakeholder equity.
Strong stock performance:
If the stock does not have the potential to double itself in the five years, it does not come under the growth stocks. Always keep in mind that the price of the stock would double in 7 years with a rate of just 10%. To double in five years, the rate of growth must be about 15%. It is certainly feasible for novice firms in quickly expanding industries.
Advantage of Growth investing
Here are some of the common characteristics of growth investing strategy:
1) Faster growth: Growth stocks generally generate sustainable and remarkable positive cash flow, profits, revenue at a comparatively faster rate than the average firm within the same sector.
2) Premium valuation: With the conventional valuation metrics, most of the growth stocks appear overpriced. Some of the famous valuation metrics include P/B ratio, P/E ratio, P/S ratio and several more.
The traders show interest in growth stock just because they believe that the firm will continue growing and will show the rapid development in the future. If the things go in the right direction, then there are huge chances that the price of the share will surge and also shoot up, thus leading to the market-beating returns.
3) Dividends: Generally, growth firms reinvest their dividends in their company operations to enhance even more growth. The enhanced growth increases the size of your profit too.
Disadvantages of Growth investing
There are certain drawbacks or risks which investors should think upon while purchasing growth stocks of the company:
- High Valuation: Traders ready to spend a high valuation to purchase a growth stock, predicting that the firm will show rapid growth in the coming years. The higher the valuation, the greater is the expectation involved with the business. Eventually, these expectations grow into a huge pile, and it becomes impossible for the company to fulfil them. Whenever the firm presents a disappointing result in the market, it creates a situation of panic among investors. They try to exit the stock as soon as possible. It leads to a substantial decline in the price of stocks.
- High volatility: Growth stocks generally trade at a premium valuation, and hence they are more prone to large price swings. At the bullish market situation, the price of these stocks tends to surge rapidly, and when they hit, they defeat the market returns. In contrast to this in bearish market condition, their price tends to decline quickly due to involved risks.
- Execution Risk: On paper and conversations, the business plan always appears good, but it becomes problematic when it comes to implementing them in the real world.
- Cyclical: Most stocks trade in cycles in the share market. If traders purchase growth stocks when the financial market begins shifting its focus on something else, then these stocks can underperform.
How to invest in growth stocks?
Growth investing and value investing are two approaches to the stock market. Hence investing in growth stocks is similar to investing in stocks. It requires an authentic brokerage firm to pursue trading. One such broker providing trading over 300+ assets is 101investing.
101investing trading features:
- Regulated By: CySEC or Cyprus Securities and Exchange Commission.
- Maximum leverage: 1:200 for the professional account and 1:30 for a retail account
- Minimum Deposit: $250
- Trading Platform: MetaTrader 4, Web Trader and Mobile App
- Trading Instruments: Cryptocurrencies, metal, commodity, forex indices, stocks etc.
To open an online trading account with the broker, you need to follow these four simple steps:
1) Register yourself (information required: name, surname, profession, email id and phone number)
2) Uploading the documents for verification of the information supplied in step 1
3) Selecting the trade and depositing fee for the trade
4) Start trading
The Bottom Line
Growth investing can prove to be highly advantageous for a trader. However, this approach is not suitable for every investor because it brings a high amount of risk along with it. Hence the investor should take all the factors into account while making a choice. Many market analysts advise that trading decisions should be made by considering factors like economic and fundamental analysis, risk tolerance capacity and understanding of the market. If you want to learn various ways, tools or strategies for managing risk, then you can read A Guide on Risk Management on website fxreviews. best.