Growth investing is an investment strategy that makes capital appreciation its primary goal. This is the opposite of value investing which prioritizes preserving capital, even at the expense of short-term capital growth.
Growth investing considers a company’s present financial situation as well as its likelihood for future growth. Growth stocks can be volatile so having the ability to cast an objective eye on a company’s financial picture helps you understand if a recent upturn is worth chasing or if a recent downturn is a buy the dip opportunity.
This eye on the present and the future sets growth investing apart from pure speculative investing. True, there’s an element of speculation to all investing. After all, if every stock was totally predictable, everyone would be successful at investing. However, purely speculative investors tend to be traders who are only concerned about strong stock price movement in a particular direction regardless of the underlying fundamentals.
Here are a couple of tips to help you become a better growth investor:
Take Your Emotions Out Of It
When pursuing a growth investing strategy it’s important to have a few rules you can use as anchor points. When a stock is making a strong move in either direction it’s easy for emotion to take over. But emotional decisions are rarely good decisions.
Many successful investors follow an investing rule that states you should always sell a stock if it falls 7%-8% below the price you paid for it, period. Conversely, many investors set a growth target of 20% to 25% as a time to take profits.
Rely on Fundamental Analysis…to a Point
This might also be called performing your due diligence. Successful growth investors will look at fundamental analysis metrics like price-to-earnings or price-to-book ratios. But if the company appears to have the ability to deliver above-average growth they may be willing to buy the stock even if these ratios suggest the stock is overvalued.
Understand your Risk Tolerance
It’s fair to say that growth investors have a higher appetite for risk than value investors. However, growth investing has a place in almost every investor’s portfolio. While there’s a risk of some loss, growth investing is one of the only ways that investors can maximize their gains in a bull market and help to offset their losses in a bear market.
Examples of Growth Stocks
The primary criteria for defining a growth stock is that the stock is growing due to its core business operations. Some companies can show growth via cost-cutting or other accounting maneuvers. However, a true growth stock will show a company that is delivering organic revenue and earnings growth. Case studies will be written on Amazon (NASDAQ:AMZN) and the rest of the FAANG stocks are an example of growth stocks. However, this can be true of a stock even if the company is not yet profitable. Tesla (NASDAQ:TSLA) is a good example of this.
And a stock may go from being a growth stock to a value stock and vice versa. For example, for many years, Disney (NYSE:DIS) didn’t qualify as a growth stock. However, since 2010 the company has become one of the strongest growth stocks in addition to paying a dividend. This brings up another point.
A Growth Stock Can Pay a Dividend
When a company is in growth mode, it is deploying a portion of its capital to sustain its growth. This comes at the expense of tactics such as offering a dividend that directly rewards shareholders. However, growth investors are willing to accept this lack of a dividend if the company hits its growth targets.
However, in some cases, a company can achieve capital growth while still having enough capital to offer a dividend. These are typically thought of as “forever stocks” because they are loved by both growth investors and value investors.
The Final Word on Growth Investing
Growth investors prioritize capital appreciation over the preservation of capital and/or the opportunity to collect a dividend. With that said, growth investing is a strategy that every investor can practice at one time or another. Over time, the overall trend for stocks has been positive. So to avoid growth investing completely is to deny yourself an opportunity for spectacular growth.
However, like any form of investing growth investing requires discipline and the ability to evaluate a company’s true potential. Many companies can have one or two good quarters. The best companies layer quarter after quarter of solid results.