What Does Growth Investing Entail?
Growth investing is an investment strategy that focuses on businesses with higher growth when allocating an investor’s capital. The revenues of these companies are projected to increase at a higher rate than their sectors as well as the overall market. Growth investing adopts a different approach in comparison to value investing, evaluating companies based on their growth potential.
An investor using a growth investing style will aim to maximize their investment returns as opposed to obsessing over capital preservation. Most of the time growth investors ignore traditional valuation ratios such as price to earnings and price to book as these will indicate that a company is overvalued. Most of the time growth investors use metrics such as revenue growth, projected forward earnings growth and the addressable market to evaluate a company’s value.
Growth investing allocates capital to businesses with the following characteristics
1. Businesses addressing a new or large untapped market
Growing companies are normally addressing a large, untapped market. The market can be a new market spurred by an innovative product or service. In other cases, it may be a discovered niche market. Growth investors are likely to find quickly growing businesses in young companies as they are in the early stages of their product lifecycle and are nimble to execute on their growth targets. These companies are usually projected to grow their revenues rapidly as they capture their addressable market, move into adjacent markets, introduce new products and generate repeat sales.
2. Rapid Expansion
Another aspect of growth investing is that the business picks do not have to be profitable. Quickly growing businesses reinvest all their earnings to expand and spur more growth. Growth investing is not concerned with income generation that will lead to earnings distribution to shareholders in the form of dividends. The preference is for rapidly growing businesses that are expanding and increasing revenues. This leads to the markets appraising them at a higher valuation.
3. Unique Talent & Leadership
Fast-growing businesses are mostly led by visionary leaders who do not conform to standard conventions. Highly talented and skilled people are also attracted by the chance to participate in world-changing companies with the potential for a huge financial payoff.
The Drawbacks of Growth Investing
The major disadvantage of growth investing is that it is riskier than other investment styles. Companies with high growth have premium valuations based on future projected revenues and profits. If the addressable market is not big as projected, the company fails to raise enough capital for expansion or profits fail to materialize as expected investors will bail out, and the stock price will usually fall by a substantial amount.
Also, growth companies have not withstood the test of time. Their products might just be a passing consumer fad or might be faced with stiff competition by big mature companies with decades of experience and deep pockets. Finally, growth stocks experience extreme volatility which is due to investors trying to price their business performance metrics against expectations.
In conclusion, growth investing is appropriate for investors who are willing to take some risk for a huge potential payoff. This means going against traditional investing metrics and discovering companies with innovative products and a large market opportunity. Due to the risks involved growth investing requires one to be reasonably diversified. If you want to learn more about growth investing you should check out CabotWealth.com they have a good article which might explain growth investing in more detail.
Please remember this is not financial advice and all financial investments carry risks. Investors should seek financial advice from professionals before making any investment. I wrote this article myself and it expresses my opinions.