As an investor, one must choose an investment style or strategy that aligns with one’s goals, risk profile and investment horizon. Growth investing is one such strategy that investors employ for increase in capital.
So, what is growth investing?
Growth investing is a strategy wherein the aim is on increasing the wealth or capital of the investor with focus on the potential of a stock’s future growth. The growth investor focuses on growth stocks which show immense potential for growth at a pace that’s faster than the average market growth.
Typically, growth stocks belong to companies that are growing at a faster pace than their competitors and offer innovative products and solutions. Value investing, on the other hand, focuses on companies that have intrinsic value but are currently trading for lower than their worth.
Among the first rules of growth investing is to identify companies that are fast growing. To do that, you would need to identify industries that are growing fast, where a new range of products or solutions are coming up. Focusing on trends that have emerged in the recent past and companies that are banking on these trends will help you identify growth companies.
Now that you know what is growth investing, here are seven rules of growth investing you should keep in mind:
1. Look at P/E and PEG ratio: Growth companies have a high P/E ratio. The P/E ratio is the market value per share/earnings per share. Higher the P/E ratio means a higher price investors are willing to shell out for a share because of growth expectations. However, in some cases, this ratio may not truly show the health of a company as it might just mean that the business is overvalued because of inflationary tendencies or a boom. The price-earnings to growth (PEG) ratio should be looked into apart from P/E ratio. The PEG ratio is market value of share units/earnings per share growth rate. This accounts for annual rise in the company’s EPS.
2. Look at growth in sales: Track rise in sales for any specific quarter when compared to the same quarter in the earlier year. This tells you how a company is growing year on year. Quarterly growth in sales followed by consistent annual growth ratio wherein growth rate is rising each year shows that a company is in good financial health and is offering new products/services or diversifying its business or is tech empowered, among others.
3. Focus on company’s EBITDA: EBITDA is earnings before interest, taxes, depreciation and amortisation, and looking at a company’s EBITDA year on year shows its operational profitability, ie, the amount of cash it is generating from the business.
4. Look at the growth in net profit: If the company has shown growth in net profit year on year, it means that it has been able to generate profits once all the expenses have been deducted from revenues. This is an indicator that the company has a strong market for its products or services and is on a growth path.
5. Track earnings per share: Companies that qualify as growth firms should show a strong growth in earnings per share over the years, at least over the last five to ten years. The premise behind looking at EPS is that if a company has shown a high growth in the past, it will in likelihood show a good growth rate in the future.
6. Watch out for earnings announcements: Earnings announcements are made every quarter or year and made on particular dates in the earnings season. Companies make public statements on their profitability. Before these announcements, companies also release estimates made by analysts. As a growth investor, you would need to pay close attention to these estimates as they show if the company may grow at a rate faster than the average growth of the industry it is in.
7. Diversify your stock portfolio: One of the most important rules of growth investing is to diversify your portfolio. This applies to all investments but becomes all the more important if you want to invest in growth stocks. Make sure not to have all your eggs in the same basket especially in growth investing. You could have five to ten stocks depending on whether you are a small investor or a fairly moderate one.
Now that you know what is growth investing and what to keep in mind, it is time to pick some growth stocks and invest in them. Identifying growth companies means tracking key aspects such as earnings per share of the company over the past five years or so, looking at net profits, the company’s EBITDA, watching out for its earnings announcement and estimates, and assessing how it is doing relative to market growth. If the company is growing faster than its competitors in the market and is showing great potential for growth, it is something you should be looking at, as a growth investor.