Growth Investing

Updated on March 26, 2024
Article byWallstreetmojo Team
Edited byWallstreetmojo Team
Reviewed byDheeraj Vaidya, CFA, FRM

What Is Growth Investing?

Growth Investing refers to capital allocation in potentially high-earning companies such as small caps, startups, etc., that grow much faster than the overall industry or mature companies. As the returns in such investments are high, the risk faced by such investors is higher too.

Growth Investing

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Investors usually pick stocks that have good future potential even though they might be small or new companies. They are mostly in sectors that are rapidly expanding, like new technology. Thus, along with the risk involved, there is also good probability of future returns if proper analysis is done.

Key Takeaways

  • Growth investing is the appropriate capital leverage provided to certain small startups and budding companies, which have the potential growth to provide faster returns to their investors. 
  • Growth investing stocks are very important as it tends to give satisfactory returns, and the stock price movement is directly related to the company’s profitability. 
  • The pitfalls of growth investing are that managers focus on future returns rather than the current numbers held by the company. Additionally, the safety margin is comparatively lower in small-cap or mid-cap organizations. 
  • Such kind of investing happens mostly in rapidly expanding sectors like technology.

Growth Investing Explained

Growth investing is investing in stocks of companies with good future growth potential, usually in any rapidly expanding sector. These companies have a better capacity to increase their profits and are in a better position to survive the competition.

If business strategy is strong, growth investing stocks show sudden rise in price within a limited time span. Companies with good growth potential will have a relatively higher earnings per share (EPS) and also a higher price earning ratio (P/E ratio) compared to their competitors.

High growth investing stocks are mostly of emerging sectors like virtual reality, artificial intelligence, robotics, and biotechnology and stocks that fall under this category show outperformance within a short time, in spite of being recent entrants in the market.

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Strategy

There are many ways to identify growth investing companies.

  1. Stock performance – Investors can analyze the stock’s performance by keeping track of the price at which it is trading and the reasons for change if any.
  2. Return on equity – Understanding the return generated from the capital investors invest in the business with the aim of long term growth investing. If a return is good, the business is using the money wisely and expanding. This means it has good prospects.
  3. Profit margin – The profit margin helps to analyze whether the business can cover its costs and still has extra money for future expansion.
  4. Historical performance – This performance will show how the company is progressing.
  5. Peer comparison – High growth investing stocks usually perform better than their peers, giving high growth with high risk.

Growth Investing in Video

 

Examples

Let us look at some examples to understand the concept.

Example #1

Portfolio A and Portfolio B consist of four stocks each. At the same time, portfolio A has given a return of ~28%, and portfolio B has generated a return of ~7.5% during the bull marketBull MarketA bull market occurs when many stock prices rise 20% from a recent low, with the price climb spanning for an extended period.read more scenario. Portfolio A consists of blue chips and growth stocks, while portfolio B consists of defensive stocksDefensive StocksA Defensive Stock is a stock that provides steady growth and earnings to the investors in the form of dividends irrespective of the state of the economy as it has a low correlation with the overall stock market/economy and is therefore insulated from changing business cycles.read more, whose profitabilityProfitabilityProfitability refers to a company's ability to generate revenue and maximize profit above its expenditure and operational costs. It is measured using specific ratios such as gross profit margin, EBITDA, and net profit margin. It aids investors in analyzing the company's performance.read more grows less than the GDP.

The index has generated a return of 13.5% during the period. Thus, we may conclude that during good times portfolio A will surpass the index return during a good bull market, while defensive stocks will generate a return that is less than the index.

Example #2

During the recession, we have seen that the price-to-earnings metrics tend to erode, irrespective of the quality of the stocks, because of the negative investor sentiment. Thus, richly valued blue-chip stocks become cheaper because the market will discount the overall sentiment and will drive the price lower. On the other hand, slow growers or defensive categories remain in the same range.

The reason is that irrespective of the market conditions, the price to earningsPrice To EarningsThe price to earnings (PE) ratio measures the relative value of the corporate stocks, i.e., whether it is undervalued or overvalued. It is calculated as the proportion of the current price per share to the earnings per share. read more multiples or other valuation metrics remain low for these categories of stocks. So, during economic recessionsEconomic RecessionsEconomic recession is defined as the phase in which economic activities of a country become stagnant, leading to a disturbance in the business cycle and affecting the overall demand-supply balance. read more or slowdowns, these slow growers resist the portfolio’s drawdown.

Pros And Cons

Let us understand the pros and cons of growth investing companies.

Pros

Cons

Growth Investing Vs Value Investing

Growth investing involves purchasing stocks that investors classify as having good future growth potential, whereas value investing is in stocks that are undervalued in the stock market. The primary differences between them are as follows:

Growth InvestingValue Investing
Stocks are usually overvalued or fairly valued.Stocks are usually undervalued.
The price earning ratio is generally high.The price earning ratio is generally low.
Dividend yields are low.Dividend yields are high.
They have high risk along with high return.They have low risk with low return.
Volatility is high.Volatility is low.

Frequently Asked Questions (FAQs)

What are the examples of growth investing?

Growth investing includes high volatility stocks providing high returns, such as penny stocks, futures and options, foreign currency and real estate, etc.

Is investing in Growth Fund a wise idea?

A long-term investment perspective and a healthy risk tolerance are recommended for market participants because most growth funds are high-risk, high-reward investments.

Are growth stocks hazardous?

Growth stocks are highly volatile as they do not offer dividends; the only way an investor may profit from their investment is by eventually selling their shares. If the company does not do well, it can lead to the downfall of the investor’s investment.

This has been a guide to what is Growth Investing. We explain its differences with value investing, strategy, pros and cons along with examples. You can learn more from the following articles –

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