When trying to define growth investing, the easiest way is to compare it to value investing. Value investors try to find stocks which they can trade for less than their intrinsic value. In contrast, growth investors are looking to increase the company’s potential in the future.
In addition, growth investors look for stocks that are trading higher – but they expect the intrinsic value to grow and surpass expectations. Furthermore, one of their main goals is to earn a profit through long-term and short-term capital appreciation.
Capital Gains and Profit
Growth investors try to find new and exciting companies that have a potential to grow. They are not after the dividends. Instead, they expect their investments to advance.
Furthermore, the main idea is to grow their wealth by reaching higher stock prices in the future. Because of that, they typically invest in new technologies and focus on capital gains instead of dividends. In addition, they are usually after the young companies that are expected to succeed in the near future.
What to Focus On?
There isn’t a formula that will help you evaluate the potential for all types of growth stocks. It requires you to trust your judgment and a high level of individual interpretation. Even though there are certain methods that growth investors use, they cannot apply them to all industries.
You would, therefore, have to take into consideration the past performance of a company. In addition to that, you would also have to evaluate the industry’s performance as well. Because there is no “one size fits all” solution, it is vital to have at least a framework for your analysis.
You can trade growth stocks anywhere, but the best ones are usually in the fastest-growing industries. Here are a few factors you should consider and include in your own strategies:
Look for healthy historical growth. Before you select your stocks, make sure that the company has a decent track record. They should have had a steady earnings growth during the last five to ten years. However, bear in mind that the minimum of growth depends on the size of the company. If a company is worth more than $4 billion, look for at least 5%. However, if the value is under $400 million, the growth should be 12%. If they grew in the past years, there is a higher chance of them continuing to prosper.
- Check their forward earnings growth. Companies use an official public statement to announce how much they have profited in a specific period. However, the part you should also be interested in is the earnings estimate. That determines whether or not the company will continue to grow.
- Find strong profit margins. It is essential to evaluate the pretax profit margin before you invest in growth stocks. This metric will allow you to see if the company controls their costs and revenues well. If they exceed their previous five-year average, then they might be an excellent growth candidate.
- Look for a fantastic return on equity. ROE evaluates the profitability, and it reveals how much profit the company is making. If the company’s five-year average ROE stays stable, or it increases, then that company is doing a good job.
- Stable stock performance. If you cannot see the stock doubling in five years, then it probably isn’t material worthy of growth investing. Remember that the price would double at a growth rate of 10% in just seven years. Therefore, if you invest in a young company that has significant growth potential, their stocks must double at a rate of 15% in five years. Although it might seem challenging, this is entirely possible if you pick an excellent up-and-coming company.