What is Growth investing?
Growth managers invest in companies that they believe will grow earnings faster than the overall market. These tend to be leading companies in rapidly growing industries, and/or companies with a competitive advantage,such as a proprietary product or service. These companies should also be able to continue growing through the introduction of new products, sales expansion, acquisitions or some other method. Growth managers believe that earnings are the key component driving stock prices
What are Growth stocks?
Growth stocks are characterized by high earnings per share (EPS),high return on equity (ROE),high price to earnings ratios and low dividend yield.
SPECTRUM OF GROWTH STYLES
Among the variety of strategies implemented by growth investors, ranging from aggressive growth stocks to steady growers, there are benefits and drawbacks.
These companies tend to be the fastest growers of the market, exhibiting a high level of earnings and revenue growth compared to their peers. In return, an investor must accept more price volatility. In seeking maximum returns, an investment strategy focused on aggressive growth anticipates this greater volatility.
These stocks frequently attract the media’s attention, as earnings can fluctuate from quarter to quarter or differ from analysts’ expectations, resulting in rising or falling stock prices based on earnings, product or service developments, or investor sentiment. Many aggressive growth companies are in cyclical businesses, as consumers increase their discretionary spending when the economy is growing and restrict spending in a downturn. As a result, aggressive growth stocks tend to perform well in economic upswings, but poorly during economic downturns.
Investors who apply the momentum growth strategy seek to take advantage of market volatility and investor sentiment. Based on the idea that “what goes up will keep rising,” these investors generally attempt to boost alpha by taking a short-term position in stronger performing stocks and selling shares when they show signs of price weakness. Many momentum investors calculate the relative strength over a set time frame to find the strongest performers compared to the overall market. Because buy/sell timing is critical, the momentum growth investor needs to accept the risk of incorrect timing as well as costly high turnover. In general, momentum growth works best in a bull market and when investors are exhibiting more herding behavior.
Consistent, Steady Growth
In general, many companies that grow at a consistent pace tend to be under investors’ radar because they do not necessarily attract the most attention relative to faster growing stocks. In a strong market, these stocks are likely to underperform, yet over longer time periods, superior and more stable growth may be achieved. While aggressive stocks tend to be cyclical, many steadily growing companies tend to be in more defensive areas of the market, such as consumer staples, industrials and materials. Due to the nature of many of these less cyclical businesses, earnings and stock price tend to be much more consistent, and therefore, often experience lower volatility. Investment strategies focused on steady growth, such as those employed by the Value Line Funds, tend to emphasize companies that have demonstrated an ability to increase earnings and stock price consistently over full market cycles.
Value Investing VS Growth Investing
Growth stocks are more likely to beat their competitors and outperform everyone in the future. Whereas the value stocks are currently down and are priced opposite to their real worth. Value stocks can bring huge profits if they perform well in the future. So how to identify which one is better and suits your investment goals?
When you compare value and growth stock it is evident growth stocks are expensive owing to their future potential. Whereas the value stocks are currently available at lower prices due to their lower revenues and profits. Growth stocks continuously yield higher profits and hence investors prefer growth stocks. The value stocks tend to yield profits but the time required to get profits from value stocks can be huge.
The risk factor in growth stocks is higher owing to higher valuations and continuous price fluctuations due to unfavorable market conditions. Growth stocks can experience a decline in valuations due to any kind of negative sentiments. Value stocks are considered less risky as they move gradually and there is no sudden decline or improvement. They assure a better dividend pay record which attracts the investor during poor market conditions.
Types of growth investments include the following:
The size of a company is based on its market capitalization or net worth. There is no exact, universal definition of what is considered to be “small-cap” compared to micro, mid or large-cap, but most analysts classify any company with a capitalization of between $300 million and $2 billion as a small-cap firm.
Companies in this category are usually still in their initial phase of growth and their stocks have the potential for substantial appreciation in price. Small-cap stocks have historically posted higher returns than their blue-chip cousins, but they are also considerably more volatile and carry a higher degree of risk. Small-cap stocks have also often outperformed large-cap stocks during periods of recovery from recessions.
Technology and Healthcare Stocks
Companies that develop new technologies or offer innovations in healthcare can be excellent choices for investors who are looking for a home-run play in their portfolios. The stocks of companies that develop popular or revolutionary products can rise exponentially in price in a relatively short period of time.
For example, the price of Pfizer (PFE) was just under $5 a share in 1994 before Viagra was released. This blockbuster drug took the company’s stock price to above $30 a share over the next five years, thanks to FDA approval of the drug in 1998. On occasion, a growth stock can go on a wild ride. Streaming media company Roku (ROKU) surged in the months after its initial public offering (IPO) in the fall of 2017, only to retreat towards the closing price from its first day of trading just a few short months later.
Thrill-seekers and speculators look to high-risk growth instruments such as penny stocks, futures and options contracts, foreign currency and speculative real estate such as undeveloped land. There are also oil and gas drilling partnerships and private equity for aggressive investors in high-income brackets. Those who pick the right choices in this arena can see a return on capital of many times their initial investment, but they can also often lose every cent of their principal.
Researching Growth Stocks
There are several key factors that must be considered when evaluating investment growth. The rate of growth, the amount and type of risk and other elements of investing play a substantial role in the amount of money that investors walk away with.
When it comes to stocks, some of the data that growth investors and analysts examine include the following:
Return on Equity (ROE)
ROE is a mathematical expression of how efficiently a corporation can make a profit. It is quantified as a percentage that represents the company’s net income (which in this case means the income remaining after the preferred stockholders have been paid but before the common stock dividends are paid) divided by the total equity of the shareholders.
For example, if one corporation has total shareholder equity of $100 million while another company has shareholder equity of $300 million and both companies have net income for the year of $75 million, then the company with the smaller shareholder equity is providing a greater return on equity because it is earning the same net income with less equity.
Increasing Earnings Per Share (EPS)
Although there are several types of EPS and the amount of money earned on a per-share basis does not tell the whole story about how a business is run, a company whose earnings per share are increasing over time is probably doing something right. Investors often seek companies that have an increasing EPS, but further research should be done to ensure that the EPS numbers are the result of genuine cash flow from legitimate business dealings.
Many day traders and short-term investors pay close attention to projected earnings announcements because they can have both immediate and future effects on a company’s stock price. In fact, many investors make money trading earnings announcements.
For example, when a company’s projected earnings come in higher than expected, the stock price will often rise quickly and then trend back down in the following days. But consistent positive projected earnings reports will help the stock to rise over time.
Spotting Growth Investment Options
You may have decided to indulge in a bit of growth investing, but how do you pick the best growth stocks from the markets? There are some key parameters to give you a clue about which stocks make good growth stocks. In assessing a company’s potential growth, the following parameters are judged by growth investors:
- Historic Data – Companies may be fresh and young, but some of these would have displayed a sound earnings track record over a period of, say, 5 to 10 years. The size of the given company counts and investors may look for a 5% growth in companies that have a turnover of above, say, $4 billion, 7% of growth for companies that range from $400 million to $4 billion, and so on and so forth.
- Strong Growth Going Forward – Past growth rates tell you a lot about a company’s potential, but future earnings are vital too. For instance, companies make announcements of their future earnings and profitability for specific periods. These announcements can give investors clues as to whether companies are growing or declining, and at what rates.
- Robust Margins of Profit – The ‘pretax profit margin’ of a company can be computed by making a deduction of all expenses out of sales and dividing this by sales. This metric becomes crucial to consider as a company may show magnificent sales growth, but a paucity in earnings gains. As a result, this gives inventors some idea about how the management is running the company, implying that the management may not be controlling revenues and costs in the most ideal way. Generally, if any company displays an excess in its past five-year average profit margins (pretax), and the profits of its industry, the company is a good candidate for its stocks to be represented as growth stocks.