What Is Growth Investing?
Let me explain growth investing directly: it's a strategy where you invest in companies that show strong potential to grow faster than their industry or the overall market, aiming for capital appreciation. These growth stocks can offer substantial returns if the companies succeed, but they come with higher risks since they're often new or unproven. As a growth investor, you'll focus more on profits from rising stock prices than on dividends, considering elements like earnings potential, market position, and innovation. This approach contrasts with value investing, which hunts for stocks trading below their intrinsic value.
Key Concepts of Growth Investing Explained
You should know that growth investors target investments in rapidly expanding industries or markets with emerging technologies and services. The goal is to profit from capital appreciation—gains from selling stocks—rather than dividends, as most growth companies reinvest profits back into the business. These are typically small, young companies with high potential, or those newly public. The expectation is that their growth in earnings or revenues will drive up stock prices over time. That's why growth stocks often have high price/earnings ratios; they might not be profitable yet but are projected to be, thanks to patents or advanced technologies that keep them ahead. They reinvest to innovate and secure patents for long-term growth. Remember, this is also called a capital growth or appreciation strategy because the focus is on maximizing gains.
How to Assess a Company's Growth Potential
When evaluating a company's growth potential, there's no one-size-fits-all formula— it involves your interpretation of objective and subjective factors, plus judgment based on the company's history and industry performance. Generally, you look at five key factors for capital appreciation potential. Companies need a track record of strong earnings growth over the past five to 10 years, with minimum EPS growth varying by size—say, 5% for large firms over $4 billion, 7% for mid-sized, and 12% for smaller ones. If they've grown well recently, they're likely to continue. Forward earnings growth matters too; watch earnings announcements and analyst estimates to spot companies growing above industry averages. Profit margins are crucial—calculate pretax margins by deducting expenses from sales and dividing by sales; if a company beats its five-year average and industry norms, it's a candidate. Return on equity shows profitability from shareholder investments—compare current ROE to five-year averages for stability or increases, indicating efficient management. Finally, stock performance: if a stock can't realistically double in five years (needing about 15% growth), it's probably not a growth stock. You'll find these in fast-growing industries on any exchange.
Growth Investing Compared to Value Investing: Key Differences
Understand that growth and value investing are often seen as opposites. Value investors seek stocks below intrinsic or book value, like bargain hunting, while growth investors consider fundamental worth but ignore indicators of overvaluation, focusing on future potential. You might buy stocks trading above intrinsic value, betting it will grow to exceed current prices. If you're interested in diving deeper into growth investing, value investing, or related topics, consider one of the top investing courses available.
Influential Figures in Growth Investing
Let me tell you about key figures who've shaped growth investing. Thomas Rowe Price, Jr., is considered the father of this strategy; in 1950, he launched the T. Rowe Price Growth Stock Fund, which averaged 15% annual growth for 22 years, and today his firm is a global giant. Philip Fisher detailed his style in his 1958 book Common Stocks and Uncommon Profits, stressing research and networking—it's still a go-to resource. Peter Lynch, from Fidelity's Magellan Fund, developed the 'growth at a reasonable price' (GARP) hybrid of growth and value.
Real-World Example of a Growth Stock: Amazon
Take Amazon Inc. (AMZN) as a prime example—it's been a growth stock for years and remains one of the world's largest companies. In 2021, it held a top-three spot in U.S. market cap. Its stock often has a high P/E ratio, staying above 70 from 2019 to early 2020, then around 60 in 2021. Despite its size, projected EPS growth was about 30% annually for the next five years. Investors pay premiums expecting future growth, making current prices seem cheap later. But if growth falters, prices can drop sharply—that's the risk.
The Bottom Line
In summary, growth investing targets companies growing faster than peers for high rewards through capital appreciation, but it involves risks with unproven businesses. Unlike value investors focused on undervalued stocks, you prioritize future potential and may pay premiums. Weigh earnings growth, margins, ROE, and performance in decisions. Figures like Price, Fisher, and Lynch demonstrate its effectiveness, but assess your risk tolerance and goals before committing.
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