Growth investing has historically yielded great results for investors. However, before you get started, it is important that you understand the risks and strategies that will help your portfolio grow.
To explain growth investing, it is easiest to compare it to value investing. Value investors look for stocks that are currently trading for less than they are worth. On the other hand, growth investors look at future growth of the company without as much attention to the current price. Growth investors are willing to pay more than the intrinsic worth with the hope that the stock will continue to grow.
Growth investing seeks high potential stocks
Growth stocks are fast growers, and are often young companies. The thought is that the more earnings a company has, the more the stock will grow. Investments are often made in rapidly growing industries in new technology fields. Growth stocks typically do not pay dividends so the value of the investment is realized by increases in the share price, converted to capital gains upon sale of the stock.
Growth investors do not have a specific formula to follow when looking at growth potential. For many investors, they rely on their own personal judgment and experience in developing trades. Any criterion that they do use is based on the company’s individual situation. They have to consider a company’s history and the performance of the industry to determine its future growth.
Fundamental strategies of growth investing
The National Association of Investors Corporation is known for developing and teaching strategies for growth investing. The goal is to teach investors how to put their money into the market wisely. They have developed guidelines that can be used to make growth investing easier.
First, you need to consider the historical growth of a company. A strong earning history of at least five years, and preferably more, is often a good indicator, as they will be expected to continue to grow in the future. However, that strategy would exclude new companies that do not have a quantifiable growth trend yet established.
Secondly, you should look at the forward earnings growth. A projected five-year growth rate of at least 10% is preferred, and the higher the better. Keep in mind that these are only estimates, and the financial information used should come from a reliable source, such as the company’s financials filed with the Securities and Exchange Commission (SEC) . It is also helpful to fully understand the company’s industry dynamics to ascertain long-term potential.
Third, you will want to look at the quality of the company’s management, as well as pre-tax profit margins, since those should keep pace with sales growth. By comparing the two, you will obtain a better idea of how well the management is working, and whether they are wisely managing costs and revenues.
Fourth, you need to evaluate the efficiency of the management. You can determine this factor through reviewing a growing or stable return on equity. Again, you want to compare this to the industry and the company’s history.
These factors can all help you decide whether or not a company will become a profitable growth stock. Of course, this information is always subjective to the investor, and some may be more willing to take risks on borderline companies than others. Ultimately, you will have to come up with your own guidelines and strategies in choosing growth stocks. Consider your risk-to-reward ratio, along with the current diversification of your portfolio, and you can find the right growth stock mix for your risk tolerance.