- Growth investing is a high-risk, high-reward, long-term investing strategy that focuses on investing in growth stocks.
- Growth stocks usually have a high price-to-book (P/B) ratio because investors are predicting the stock to grow.
- Growth investors should be able to stomach volatility in the market, and those shares shouldn’t make up your entire portfolio.
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In the ’80s and early ’90s, it was a good time to be a growth investor.
If you bought a single share of Apple stock when it first went public in 1980 at $22 per share and held it through its five splits — three at 2-1 from 1987 to 2005, one at 7-1 in 2014, and one at 4 -1 in 2020 — you’d have 224 shares at around $170 dollars per share.
“There are certain growth stocks, the mega winners, that if you picked back in their IPOs in the ’90s and you held through their recessionary periods, your returns would be massive right now,” says Daniel Demian, a senior financial advisor at Albert .
Though chances are, your growth investing won’t provide the monumental returns you would have earned if you invested in Apple or Amazon decades ago, it’s still an appealing — albeit risky — way for investors to try and outperform the market. Here’s what you need to know about growth investing.
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What is growth investing?
Growth investing is a long-term investing strategy that heavily emphasizes buying growth stocks, which are stocks from companies that are projected to outperform the overall market.
Most companies that fall under growth stocks don’t pay out dividends to their shareholders, opting to reinvest those dividends back into the company to facilitate growth. They may also be newer companies or small-cap companies. Additionally, growth stocks tend to fall under certain industries that are also experiencing fast growth such as technology.
“Think, information technology, blockchain technologies, new medical treatments, new web technologies. Anything that has high growth potential, that’s going to be your industry,” Demian says. “You typically won’t find an aggressive growth stock under a utilities company, because those have a different clientele. And the investors in those companies aren’t really looking for that aggressive growth. They’re looking more for dividend payouts, they’ re looking for a stable income.”
Growth stocks won’t offer dividends or will over very small dividends and will often have a high price-to-book (P/B) ratio, which means their shares are being overvalued compared to their actual worth. This is because you’re not only buying into the company, but their future growth. This means you’re overpaying for the stock compared to something like a value stock.
Because the value of the stock is higher than the actual value of the company, growth stocks come with higher risk than other types of stocks. “I’m going to buy this company because they’re going to release a spaceship next year. Now, next year comes, and they don’t release a spaceship. At that point, I overpaid for something in year one that promised me a spaceship in year two,” Demian says.
Who is growth investing for?
Because growth investing is a long-term investment that involves a high level of risk, a growth investor needs to be able to take on a high level of volatility while also having the excess funds to lock away in an investment that may take several years to mature. This also means that these investments should be tied to long-term goals, such as retirement or perhaps building something that you can pass down to your children.
How to invest in growth funds
While determining if growth investing is right for you given your portfolio and goals, it may also be worth considering the overall market and economy when you’re making decisions. Growth stock purchases are best made when the economy is growing. “Everything is going up, the economy’s doing good, people are spending money. They’re willing to take more risk in the stock market,” Demian says.
Lay out all your options: You can start the current buying process by narrowing your focus down to growth stocks. You can do this by downloading software that allows you to look for stocks on any index with certain criteria.
You want to be looking for stocks with a higher P/B ratio that’s higher than the index average, which is usually a good indicator that investors are treating a stock as a growth stock. You will also want to filter by stocks that pay very little dividends or no dividends at all. Add these onto your search criteria, and you should have a list of all the growth stocks, which you can then choose from.
What to look for: For the average investor, picking individual growth stocks may be too complicated. That’s where growth mutual funds and growth ETFs can allow you to participate in the growth market without having to go through the process of picking winners. However, if you want to pick individual companies you believe are going to grow, you can split your evaluation between a qualitative and quantitative assessment.
On the qualitative side, beyond determining if the product that company is offering is of value, you should look at the quality of the leadership, which means how long they’ve been working there and how much they’re being compensated. It may also be helpful to look at the earning reports, specifically if leadership is buying back their company’s stocks. This will also be a good indicator of whether the leadership itself believes in the company’s potential growth.
Quantitatively, you want to see consistent acceleration in sales growth as opposed to sales growth that is slowing down or fluctuates irregularly. You also want to see the company’s return on equity (ROE), which indicates how effective a company is at generating revenue. This should be higher than other companies within its industry.
Balancing growth investing in your overall portfolio: Growth funds should not be the sole type of investment in your portfolio. They should instead exist to increase the potential gains of an overall portfolio, which will in turn also add some
“As an individual, you don’t want to have yourself tied individually into one stock or one sector,” Demian says. “So you don’t want to say ‘I’m only going to be a growth investor,’ or ‘I’m only going to be a value investor,’ or ‘I’m only going to invest in technology companies,’ because you want to diversify your portfolio.”
Growth investing vs value investing
In growth investing, investors try to pick companies that have the potential to grow and eventually out-perform the market. Value investors, on the other hand, are looking for companies with stocks that are currently underperforming compared to how well the company is doing.