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Growth investing is a strategy that involves identifying and investing in companies expected to grow significantly faster than the broader market. This growth is typically reflected in increasing revenues, profits, and market share.
Unlike value investing, which looks for undervalued stocks, growth investing focuses on companies with strong potential for future expansion. Understanding the fundamentals of growth investing can help you identify high-growth stocks. This will help you make the most of investment opportunities and reduce the chances of selecting suboptimal stocks.
It refers to an investment approach where the primary goal is maximising profit in the long term. It usually involves investing in companies that have the potential to increase profit faster than their competitors in the same industry.
These companies often reinvest their earnings back into the business rather than distributing them as dividends. The expectation is that the reinvested amount will lead to future growth and eventually boost its stock prices in the future.
Investing in a high-growth stock differs from income investing. The latter favours more established and predictable businesses that pay dividends. Growth investing typically involves allocating capital during the early stages of a company, when uncertainty is higher, with the objective of achieving substantial returns over time.
Growth investing involves analysing a company’s potential to scale meaningfully over time. It includes the following steps
Revenue Growth: Consistent increases in top-line revenue and a strong earnings record over multiple years may indicate potential for favourable returns
Earnings Growth: Rising Earnings Per Share (EPS) over several quarters
Return On Equity (ROE): Indicates how efficiently the company generates profits
Retention Ratio: High retained earnings for business expansion
Competitive Edge: Strong brand recognition, innovation, or intellectual property
Long-Term Focus: Most growth investors aim to hold stocks for several years
Compounding Effect: Capital appreciation builds over time, often significantly
Regular Monitoring: As an investor, comprehensive information about a company’s performance and industry developments is vital
Diversify Your Portfolio: Diversifying across growth stocks and sectors can reduce risk from market volatility
Growth investing offers specific benefits tied to the nature of high-growth companies. The points below outline some potential advantages of pursuing this investment strategy.
These stocks can deliver strong returns when the underlying company meets or exceeds earnings expectations. You can benefit from rising share prices, especially when the market recognises the company's potential.
Growth investors often gain exposure to companies that are transforming industries through innovation. These may be the first movers in their fields.
Growth companies tend to reinvest profits to expand operations, enter new markets, or develop new products. This may lead to exponential growth.
When a company isrecognised as a growth stock, it may attract interest from institutional investors. This can boost liquidity and price discovery
Investing in growth stocks involves certain risks that differ from more established or income-focused investments. The points below outline some key considerations associated with this type of investment.
Growth companies typically reinvest profits for expansion. So, as an investor, you may not receive regular income in the form of dividends.
These investments involve strategies with uncertain outcomes, which may result in long-term losses. They are also highly sensitive to changes in market conditions.
The performance of these stocks depends on broader market trends. They tend to perform well in favourable market conditions but may decline when the market weakens, especially during the initial stages of the company or industry.
Temporary economic growth can inflate stock prices beyond their actual value. This creates a risk of overvaluation and potential corrections.
To navigate this exciting yet challenging growth investing landscape successfully, you need a clear framework. Here are a few things to keep in mind:
Past Earnings Performance
A strong indicator of a company's upward trajectory is its historical earnings. Look for growth stocks that have consistently shown tremendous earnings growth over the past decade.
Stock Price Trend
Keep a close eye on the stock's current price performance. A truly growing company in an expanding industry shouldn't take an excessively long time to double its stock price. Look for a consistent upward trend.
Future Growth Prospects
The company should operate in a growing industry or sector. More importantly, the company itself must demonstrate the potential to outperform both the broader market and its industry in the long run.
Peer Benchmarking
A strong growth stock should be outpacing its competitors. Its growth rate should be significantly higher than that of its peers, with no rivals coming close to matching its performance.
Return on Equity (ROE)
A high Return on Equity indicates that the company is effectively utilising the capital invested by its shareholders to generate profits. Companies with an ROE significantly above their industry average are often excellent candidates for growth stocks.
Profit Margins
Look for companies that are currently profitable or show a strong likelihood of becoming profitable in the near future. Robust revenue growth alongside persistent losses can suggest that the company's management isn't effectively controlling costs.
Stock market growth investing is often compared with value investing. However, these investment approaches differ in methodology.
Value investing focuses on identifying stocks that appear to be undervalued based on fundamental analysis. Growth investing, on the other hand, involves selecting companies expected to grow at an above-average rate.
The table below outlines the key distinctions between the two styles:
Feature |
Growth Investing |
Value Investing |
|---|---|---|
Focus |
Future earnings and expansion |
Undervalued stocks based on fundamentals |
Stock Price |
High |
Low |
Horizon |
Longer |
May have a shorter-term |
Popularity |
In-favour stocks |
Out-of-favor stocks |
Valuation |
High P/E, high market expectations |
Low P/E, margin of safety |
Volatility |
Higher |
Lower |
Dividend Payout |
Usually low or none |
Moderate to high |
Risk Level |
Moderate to high |
Low to moderate |
Growth investing can be a rewarding approach if you are willing to take on some risk in exchange for potential long-term capital gain. By investing in companies with consistent revenue growth and stable financial performance, you can potentially benefit from gains over time.
This content is for informational purposes only and the same should not be construed as investment advice. Bajaj Finserv Direct Limited shall not be liable or responsible for any investment decision that you may take based on this content.
Sources
https://www.bajajfinserv.in/investments/growth-investing
https://groww.in/p/growth-stocks
https://www.etmoney.com/learn/mutual-funds/growth-vs-value-investing-which-one-should-you-choose/
They are shares in a company that may grow at an above-average rate compared to its peers or the overall market.
They can be more volatile as they are dependent on future expectations, which can be unpredictable. However, thorough analysis can yield high returns.
Generally, no. Most growth companies reinvest profits to modify their products or services and build strong customer demand.
To determine if a company has growth stock, experts look for the following:
High revenue and earnings growth
Strong ROE
High reinvestment
Sector-leading innovation
Yes, many actively managed and index-based mutual funds focus on growth investing strategies.
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Posted on 05 Jun
Geetanjali Lachke
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