There are several different ways to go about investing in the stock market. Two of the most common investing strategies used by fundamental investors are known as value investing and growth investing.
The idea behind both of these investing strategies is pretty similar. The goal is to buy when stock prices are low and sell when they are high. The difference is how these investors go about analyzing a stock. While a value investor wants to see valuations that are below par compared to the sectors in which they live, the more important factor for growth investors is, well, growth.
Ultimately, growth investors look to invest in companies that are seeing growth across key metrics on a consistent basis. Here’s what you need to know about the growth investing strategy.
What Is Growth Investing?
Growth investing is an investment style that many follow with the goal of capital appreciation, which simply means to grow their money. To do so, these investors look for stocks that are either in emerging industries or represent emerging companies that are expected to experience earnings growth that outpaces the overall market.
Because share price appreciation tends to follow strong earnings and revenue growth, growth companies are known for providing compelling returns over the short term. However, it’s important to point out that this is not a long-term investment strategy because growth companies generally hit a plateau at some point.
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What’s the Difference Between Growth and Value Investing?
Growth and value investing seem to be relatively similar. Both investment strategies are based on buying low and selling high, making a profit in the middle. However, they are two very different styles of investing.
Value investors look for stocks that are already performing well in terms of revenue and earnings, but which the market has undervalued for some reason. The idea behind value investing is that the stock price will eventually make it back to fair market value, giving the value investor an opportunity to gain.
As a result of the methodology behind the strategy, value stocks don’t experience much volatility, and risks are relatively minimal when the proper research is done before investments are made.
Growth investing is about finding stocks that are likely to see growth in revenue and earnings. While the goal is to find growth at a reasonable price, these stocks are already trading at or above fair market value, and investors who buy them are banking on the high probability of volatility. As a result, growth investing is a far more risky concept than value investing.
Types of Growth Stocks
By their nature, growth stocks usually fall into one of two categories:
1. Emerging Industries
Emerging industries are markets or sectors that are in their infancy. As a result, companies in these markets have untapped potential. As the young market grows, companies within it tend to see tremendous growth in both revenue and earnings.
At present, there are three key emerging industries:
- Cannabis. At the moment, regulations are changing around the world when it comes to cannabis. As a result, an entire market has begun to emerge surrounding the plant. As legal cannabis use continues to spread around the world, companies involved in the emerging cannabis market will enjoy increasing revenues and profits. As such, there are plenty of growth stocks in the cannabis sector at the moment.
- COVID-19. The COVID-19 pandemic shook the world in 2020, thrashing economies and keeping consumers locked down in their homes. However, the pandemic has also created a vast emerging COVID-19 market. Companies that produce vaccines, treatments, and personal protective equipment are expected to see continued growth in revenue and earnings, offering up plenty of opportunities for growth investors.
- Cryptocurrency and Blockchain. Cryptocurrency and blockchain are relatively new technologies. However, these technologies are gaining steam quickly, carving out a market in and of themselves. As a result, several companies in the space are experiencing tremendous growth, pointing to opportunity for growth investors.
2. Emerging Companies
Emerging industries are a great place to find growth companies. However, you can also find growth stocks in established markets. This generally takes place when a company with a smaller market capitalization has a breakthrough in an already established market.
A great example of this would be Apple. Although it’s arguably not a growth stock anymore, it definitely once was. At one time, BlackBerry was the leader of the smartphone industry — every professional, student, and consumer wanted to get their hands on a BlackBerry device. Then Apple broke into the smartphone market with its innovative iPhone, resulting in tremendous growth in both revenue and earnings as it took control over the market.
You’ll also find plenty of emerging companies in the biotechnology sector. New therapeutic options are being developed on what seems to be a daily basis. When a new option is approved and hits the market, companies that weren’t making a penny often find themselves with tens or even hundreds of millions of dollars in revenue from the sale of their newly developed therapeutics.
Nonetheless, most emerging companies you will find that qualify as growth investments have business models that are far from proven. As such, investing in emerging companies will come with an increased level of risk and should not be attempted by beginners.
3. Rare Large Growth Companies
The vast majority of growth companies are small, emerging businesses or relatively large businesses in an emerging industry. However, you rarely find a blue-chip stock that acts as a growth investment.
Nonetheless, it’s important to keep in mind that if there’s a stock market “rule,” there will be plenty of cases in which it’s broken.
A great example of the broken rule is Amazon. There’s no doubt that Amazon is a blue-chip stock. It’s one of the largest companies in the world and a clear leader in the retail space. However, the stock has also been a growth stock nearly since its inception.
Due to the company’s dominance in the e-commerce space its growth rate has been compelling — to say the least — in terms of revenue, profitability, and price appreciation alike. Just take a look at the company’s performance in 2020. While the market was reeling as a result of COVID-19, Amazon’s stock experienced tremendous gains, closing the year out with returns of more than 70%. That far outpaced the market, which gained between 9% and 13.5% in 2020 depending on which major index you look at.
Metrics Growth Investors Look For
When determining whether an investment opportunity is worth diving into, successful growth investors use a suite of metrics to analyze the growth potential provided by the opportunity. Some of the most important metrics to pay attention to include:
- Market Growth. Because many growth stocks are found in emerging industries, investors pay close attention to the growth of the market the opportunity lies in. After all, if the cannabis market were to suddenly shrink, the value of companies within the emerging industry will do the same. However, as the market continues to emerge and grow, stocks within the space will likely follow suit.
- Revenue Growth. Good growth companies are experiencing just that — growth. In particular, investors look to revenue growth to get an idea of the rate of adoption of the company’s products or services. Revenue will grow at different rates in different sectors. As such, when determining whether a stock is a good growth opportunity, it’s important to compare its revenue growth to the rate of revenue growth seen across its sector.
- Earnings Growth. Revenue is one thing; profitability is another. The best growth stocks are experiencing growth in both revenue and earnings. Look at the past four earnings reports provided by the company to determine if earnings are growing on a consistent basis. Although past performance isn’t always indicative of future performance, it’s a compelling clue and well worth paying attention to.
- Recent Stock Performance. Compare the stock’s performance to that of its sector over the past 12 months. Did the stock you’re looking into produce higher returns than the overall market? Does the trend look to be continuing in the upward direction? If so, you’re likely looking at a growth investing opportunity.
- P/E Ratio. Yes, growth stocks are often already priced at a fair valuation, but you also want to make sure that you don’t grossly overpay in the chase after growth. Look into the company’s valuation metrics, the most important of which is the price-to-earnings (P/E) ratio. The P/E ratio compares the current share price to the earnings per share generated over the past year. Although a normal or even slightly high P/E ratio is OK for growth investors, investing in companies with exorbitantly high P/E ratios will generally lead to losses.
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Sectors to Find Quality Growth Stocks
Don’t worry, growth stocks aren’t hiding under rocks or in some dark corner of the stock market. Because investors are ultimately the cause for movement in the stock market, these stocks are generally popular investing options.
Nonetheless, there are a few places that are worth looking for the best growth investment opportunities:
- Tech. Technology is a sector built on innovation, and where there’s innovation, there’s opportunity for growth. Look for companies that are developing the latest and greatest in new technology and you’ll likely find gems that represent compelling growth opportunities.
- Emerging Industries. Emerging industries are filled with relatively young companies that have promising value propositions. Simply look for the most popular companies in emerging industries and you’ll come across your fair share of growth investment opportunities.
- Biotechnology. New therapeutic options are being approved every day, and when a relatively young biotechnology company receives approval, it starts a process that has the potential to lead to tremendous growth. At this point, the young biotech company will market its therapeutic option, finally able to generate revenue and work toward profitability. It is at this stage in the game that growth investors strike to take advantage of the upward swings in value that are likely ahead.
Diversification in the Growth Investing Strategy
It should be made clear: growth investing is risky. Any time you chase volatility, you have a chance of tripping on a stick and falling to the bottom. So, you should be relatively knowledgeable about the stock market before deploying this strategy.
When you’re ready to start growth investing, diversification is a must. Diversification is a process by which you spread your investment dollars over several different investing opportunities. Therefore, if one stock you’ve purchased falls, your portfolio isn’t susceptible to significant declines.
Many experts suggest investors follow a rule known as the 5% rule. This rule stipulates that when investing, you should never risk more than 5% of your total investment portfolio’s value on a single stock, nor should you risk more than 5% of your total investment portfolio’s value on a group of high-risk stocks.
Growth Stocks Won’t Be Growth Stocks Forever
Growth stocks are those that are growing at a rate that outpaces the overall market. But by their nature, growth stocks won’t be growth stocks forever.
At some point — be it when competition comes into play or the market is completely saturated — a growth stock will plateau and the growth experienced will slow substantially or even reverse.
As a result, if you’re going to deploy the growth investing strategy, it’s important that you take the time to stay on top of your investments. This is by no means a “set it and forget it” investment strategy.
Pros and Cons of Growth Investing
No matter which investment strategy you choose to deploy, there will be pros and cons to consider. When it comes to the growth investing strategy, the most significant pros and cons are:
Pros of Growth Investing
Growth investing is a popular strategy, and for good reason — it works! Some of the major perks you’ll enjoy when deploying this investment style include:
- Enjoyable Research. Human beings are curious creatures. Many investors find joy in researching emerging industries and emerging companies. That’s exactly the type of research you’ll be doing when deploying the growth investing strategy. Ultimately, when research is fun, you’re more likely to do it. Because educated investments tend to be the most successful, the fact that research into exciting companies is enjoyable expands your potential for gains.
- The Potential for Tremendous Returns. Growth investing is all about capital appreciation. The strategy is deployed for one reason and one reason only: to produce gains that beat the market.
- Excitement. Growth investing is an exciting and fast-paced form of investing. So it’s a great option for the thrill-seeker who wants to turn a thirst for a little risk into an opportunity to build wealth.
Cons of Growth Investing
There is no such thing as perfection in an imperfect world. As with anything else, there are some drawbacks to consider before deploying the growth investing strategy.
- Volatility. Volatility is the name of the game in growth investing. When deploying the strategy, you’ll be looking for highly volatile runs for the top in the stock market. Unfortunately, volatility can go both ways, and reversals will generally be painful occurrences. As such, volatility is a real risk that should be considered.
- Speculation. Growth investments are highly speculative investments. Most growth companies have business models that haven’t yet been proven. Expectations that consumers will adopt a new technology, product, or service may prove incorrect, leading to significant losses.
- Research. It’s important to research any investment. However, growth investing research is more time consuming than that of other investing strategies. Because growth investing requires investing in stocks that see heavy volatility, you’ll need to devote time to keeping an eye on market news and maintaining your investments daily.
Consider Investing In Growth-Focused Mutual Funds and ETFs
There is one way to go about growth investing without having to devote too much time to the process. Instead of investing in single stocks that you believe provide strong growth opportunities, you can invest in investment-grade growth funds. These are exchange-traded funds (ETFs) and mutual funds that are centered around the growth investing strategy.
Some of the most popular growth funds include:
- Invesco QQQ Trust ETF (QQQ). The Invesco QQQ Trust ETF is one of the most popular investment funds on the market today. The fund seeks to track the performance of the 100 largest companies on the tech-heavy Nasdaq composite index. The fund has more than $100 billion under management, and for good reason. It’s known for producing compelling returns that far outpace market averages.
- Vanguard Information Technology Index Fund ETF (VGT). The Vanguard Information Technology Index Fund ETF gives investors broad exposure to the high-growth tech sector. The fund manages nearly $25 billion in assets and has been a strong producer of compelling returns since its inception.
- iShares Russell 1000 Growth ETF (IWF). The iShares Russell 1000 Growth ETF looks at the top 1,000 companies in the United States by market capitalization. It then screens them for growth metrics, stripping 500 stocks out of the average and retaining the 500 stocks that have the highest growth potential.
Growth investing is touted as one of the best ways to generate a high return on equity (ROE), and it is — if deployed properly. However, growth investing is also a risky concept that involves chasing a trend with the goal of generating returns that outpace the market.
As a result of the risky nature of this strategy, it’s best to practice a more stable investment strategy like buy and hold or value investing to learn about the stock market prior to getting involved in growth investing.
Regardless of which investment strategy you use, be sure to do adequate research and always keep in mind that the most successful investments are educated investments.