What is growth investing?
Growth-oriented investing is better known as “growth investing”. This is an investment strategy that focuses on the growth of investment capital. It involves investing in shares of companies that are ahead of their competitors. Growth stocks are shares in companies that are still relatively small and young, for example, and whose expected earnings are growing at an above-average rate compared to their economic sector, the competition or the market as a whole. These companies are often in a position to expand, which harbors great potential for returns. When selecting stocks, growth investors often use key figures such as future earnings growth, profit margins, return on equity (ROE ) and share price performance.
Growth investing can be very lucrative, provided that the expected profits are actually realized. The probability that the expected profits cannot be realized represents the risk in growth investing. In addition to growth investing, there is also the investment strategy of value investing, for example. This strategy involves selecting shares that may be trading below their value or even below book value.
Among the best-known growth investors are Peter Lynch, Philip Fisher, Thomas Rowe Price Jr. and T. Rowe Price.
Which companies do growth investors invest in?
As the name suggests, growth investors mainly invest in growth stocks. Growth stocks are shares in companies that have not yet exhausted their potential. The focus is generally on sectors and companies in which new technologies and services are being developed, i.e. industry niches with potential for expansion. Growth investors realize their profit through the capital growth of the share and usually not through dividends. Growth companies often do not pay dividends, but reinvest the dividends in the company, as this is usually more profitable with high growth than if profits were distributed. Examples of growth companies are the so-called FAANG companies Meta (formerly Facebook), Apple, Amazon, Netflix and Google.
As already mentioned, growth companies are often young and innovative companies that are able to expand. However, as the examples above show, growth can continue for a long time even if the companies are no longer young or small. Technology companies and emerging markets are commonly associated with growth investing as their share prices are often higher than their earnings or book values would suggest. Growth stocks therefore often look expensive and trade at a high price-to-earnings (P/E) ratio, but such valuations can actually be cheap if the company continues to grow rapidly, which in turn can drive earnings, and therefore usually the share price, higher. As investors pay a high price for a growth stock based on expectations, growth stocks can experience dramatic falls if these expectations are not met. Other forms of investment that pursue a growth-oriented investment strategy are recovery stocks, blue chips, or taking advantage of special situations.
The most important characteristics of growth companies
In growth investing, the investor must carry out extensive research to find companies that have the potential to grow quickly and are then able to compete with the larger, existing companies. Objective and subjective factors must be taken into account. A good asset manager can support you very well in the selection of such shares. The following factors help in the selection of companies that could offer growth in investment capital:
- Innovation, unique product lines, access to special technologies (patents)
- None Dividends
- Historical earnings growth over the last 5-10 years. Earnings per share (EPS) should be considered in relation to the size of the company.
- Strong future earnings growth: The company’s earnings announcements need to be analyzed here.
- Strong profit margins: Profit margin is calculated by subtracting all expenses from sales (except taxes) and dividing by sales. If a company generally exceeds its five-year average pre-tax profit margin – as well as that of its industry – it is a good candidate for growth.
- High return on equity (ROE): The ROE indicates how much profit a company generates with the money invested by shareholders and the retained earnings. A stable or increasing ROE can indicate that management is doing a good job of making shareholders’ investments profitable and running the company efficiently.
- Strong stock performance: A growth stock should generally be able to double in 5 years, which corresponds to an annualized geometric return of just under 15% per year.
Growth investing and value investing
Growth shares differ from value shares. Investors expect growth stocks to also achieve significant growth in investment capital due to the strong growth of the underlying company. This expectation can lead to these stocks appearing overvalued due to their generally high price-to-earnings (P/E) ratio.
In contrast, value stocks are often undervalued or ignored by the market, but can ultimately increase in value. Investors also try to profit from the dividends they usually pay out. Value stocks usually trade at a low price-to-earnings (P/E) ratio.
Some investors try to diversify by including both growth and value stocks in their portfolio. Others prefer to specialize by focusing more on value or growth. In principle, the two investment styles are not necessarily contradictory or contradictory, because even cheaply valued value stocks can show high growth, which means that growth stocks do not necessarily always have to be highly valued.