A Beginner's Guide to Growth Investing

A Beginner's Guide to Growth Investing

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Growth investing represents a strategy that investors use to seek out and invest in companies that are experiencing (or are forecasted to) above-average growth, which differs from value investing. 

Growth companies—think tech companies, for example—tend to have certain characteristics like innovative business models, strong earnings growth and significant market potential in their industry. Additional characteristics are that some growth companies have a high (P/E) ratio, with many not paying dividends as earnings will generally be reinvested back into the company. Unlike value investors who attempt to find and invest in undervalued stocks, growth investors invest in the company's future potential.

While growth investors understand that while these stocks may seem overpriced in the short term, their long-term growth can justify that investment. This forward-looking approach, however, requires a high tolerance for risk and market volatility.

Implementing Growth Investing

Before you consider venturing into the investing landscape, it is imperative that you employ funds that you are unlikely to need for at least five years. The stock market is notorious for market volatility, and you need to understand that there will always be a possibility of facing significant downturns from one year to the next. If that happens, if you are compelled to sell your stocks due to a financial emergency, you might end up selling them at a loss. Therefore, ensure that you manage your personal finances accordingly before investing.

Understanding the financial cycle can help pinpoint when growth stocks could outperform/underperform. Growth stocks tend to benefit in periods of decreasing interest rates (or the expectation of rate cuts) and underperform in periods of policy tightening. As an example, growth stocks struggled throughout 2022; you may recall that mid-March of 2022 saw the US Federal Reserve begin increasing its Fed Funds Target range, with the year ending with a Target range of 4.25%-4.50%.

Exploring market trends is another common and popular way to discover potential growth investing opportunities. An obvious example is companies that are gaining market share within an industry. Take Nvidia (ticker symbol: NVDA), for example; the company has seen explosive growth in 2023—YTD, the stock is up more than an eye-popping 230%. Although the stock has been ranging since July, price is seen testing the upper limit of the range and could refresh all-time highs in the near future.

Another strategy, of course, is investing in an industry you are familiar with. If you know a lot about a certain industry or have worked in one before, you may better understand how the market works and spot the companies that are most likely to grow. 

Using a Stock Screener

A stock screener is a valuable tool that investors can use as a digital filter to sift through the stocks available in the market. By doing so, investors can efficiently identify potential investment opportunities without manually analysing every single stock in the market. With the help of this tool, investors can make more informed decisions, tailoring their searches to find stocks that align with their investment objectives, whether they are seeking long-term growth, income generation, or a specific risk profile.

In a stock screener, you can sort companies by market cap, industry, P/E ratio, and growth rates, among other things. 

Stock Screener - TradingView

Key Points:

Strong Growth Rates

A growth stock often has high growth rates, especially when it comes to sales and earnings. Most of the time, these companies grow faster than most others in the same industry. This makes them appealing to investors as they could generate further gains in the future. They often get a bigger share of the market when they grow quickly. This makes investors put more trust in the company, which will raise the value of the stock in turn.

Reinvestment of Earnings

Often, growth companies don't provide dividends to their shareholders. Instead, it will be reinvested into the company. This way of reinvesting could be used for these companies to get into new markets, conduct more research and development, or invest in technology.

High Price-to-Earnings Ratio

The price-to-earnings (P/E) ratio is a key metric used in stock analysis. It represents the ratio of a company's current stock price to its earnings per share (EPS). This ratio can be used to check if a stock is fairly valued, overvalued, or undervalued by comparing the price investors are paying for a stock to the company's earnings. A high P/E ratio could lead to investors expecting a higher earnings growth from the stock in the future.