When someone is asking, “what is growth investing,” they usually want to know what kinds of stocks are considered growth stocks. However, growth stocks are ever-changing, so if you want to be a growth investor, you should know that growth investing is about identifying companies that are growing—obviously—and then buying their stocks. Determining what is a growth stock, is the first step to growth investing.
Stocks like Alphabet (GOOG), Amazon (AMZN), Apple (AAPL) or Snap (SNAP) (the owner of Snapchat) were growth stock leaders during the last bull run, but that’s no guarantee they’ll be in the pole position in the next.
What is Growth Investing Worth to Your Portfolio?
Because there are other factors to look for in addition to growth, the following characteristics are most desirable in growth investing:
- Growing revenues, ideally at a rate exceeding 15%.
- Growing earnings, ideally at a rate exceeding 20%.
- A good story, promising more of #1 and #2 for years to come.
- Improving investor perception, with room for further upside as more investors learn about the company.
- Growing institutional investor sponsorship, with room for further upside.
- A healthy chart, indicating that investors as a whole are growing more optimistic about the stock.
- A strong relative performance (RP) line, indicating that the stock is outperforming the broad market.
- Ample liquidity for smooth trading (our Cabot Top Ten Trader typically looks for average trading volume of at least $20,000,000 per day.)
- A price in the double digits (or higher).
- Capable management.
Growth investing involves investing in fast-growing companies that are typically less established than blue-chip companies such as General Electric (GE), Caterpillar (CAT) or Colgate-Palmolive (CL). Those global behemoths were once growth stocks themselves, but their period of rapid growth is behind them. The best growth stocks are smaller companies whose best is ahead of them.
In searching for growth stocks, you generally want to invest in companies that are growing – or projected to grow – earnings at a faster rate than the overall market. Companies growing at triple-digit rates, 100% or better, are among our favorites. (In fact, triple-digit growth has been a factor in most big winning stocks over the years).
That kind of rapid growth can overcome a number of smaller deficiencies: inexperienced management, competition, weak patent positions, etc. Furthermore, fast growth typically attracts the attention of institutional investors, who push share prices higher as they buy their way in.
Of course, the risk in growth investing is that you’re buying less mature companies that usually don’t pay a dividend. If the share price declines, you don’t have a quarterly dividend payment to cushion the fall. And these stocks can be very volatile, especially during earnings season.
While fast-growing companies have a good chance to outpace the market—sometimes by a considerable amount—they also have the potential to fall flat. Some high-growth companies are so under the radar, or so misunderstood, that the share price appreciation doesn’t match the financial growth.
The key to successful growth investing is identifying fast-growing companies before the masses do. That can be tricky, since some of the best growth stock candidates are relatively obscure. There’s a reason, after all, that the market hasn’t fully discovered them yet.
But keep things simple. Look for companies with accelerating sales, better-than-average earnings growth, and strong profit margins. More often than not, the combination of those three characteristics eventually grabs the market’s attention.
When it does, the rewards can be astonishing.
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