What Is Growth Investing?

Growth investing is one of the most popular investing styles among those looking to build long-term wealth in equity markets. Are you someone who is Googling to know more about growth investing? Hold on, your search ends right here. In this blog, we delve deep into what is growth investing?, its features, benefits, risks and much more.

What Is Growth Investing?

Growth investing is an investment style in which the focus is on companies that are expected to grow faster than the market average. These companies generally work in such a way that they reinvest their profits to expand operations, launch new products or foray into new markets. Due to these reasons, they do not pay huge dividends to its investors, but offer ample opportunities for capital appreciation.

Learn trading from experts! Join today to learn the fundamentals of trading!

Examples of Growth Investing

Curious to know about companies that fall under the growth category?. Some examples are companies that operate in sectors like technology, renewable energy, fintech, and consumer services. Amazon is a classic example of growth investing. In the mid-2000s, they ploughed back their revenues into new services such as Amazon Web Services (AWS). Though volatility was there, investors who stayed invested in the Amazon stock benefited enormously over time. 

The P/E ratio for Growth Investors

Are you new to the term P/E ratio? In simple terms, it is a ratio used by investors to check whether the companies have enough assets to liquidate while failing. If the P/E ratio is shorter, it indicates that the company has more assets than liabilities which is preferred by investors. 

The key idea in growth investing is to invest money in small and young companies. However, when the company is small and young and does not have enough assets, the P/E ratio will tend to be high. Thus, high risk is a part of growth investing and it is natural. The whole idea of growth investing is that the company will expand, prosper and the growth earning or revenues will grow to higher stock prices. 

Features Of Growth Investing

Here are the 4 important features of growth investing:

• Aims high-revenue, rapidly-expanding businesses
• Better price-to-earnings (P/E) ratios
• Thrust on innovation, scalability, and expansion
• Best suited for investors with higher risk appetite and long-term horizon

5 factors to consider in Growth Investing

Wondering how to choose growth investing companies from dozens of young and small growing companies? To keep it simple, there is no magic formula to find out the potential of a growth stock. However, you can consider the below 4 factors for picking growth investing companies.

1. Historical Growth

Historical growth is one of the important factors to consider even though the companies are small and young. As a growth investor, check for the growth of the company in the past few years. If the company has not achieved significant growth, stay away from investing in that company.

2. Profit Margins

Pretax profit margin is the next factor to consider while evaluating a company for Growth Investing. Look for profit over sales as the company might have achieved a good number in sales. Having said that, their earnings or revenue numbers might not be that impressive or appealing. In case the earnings are less despite the huge sales figure, there is a major problem in the way the company is handling revenues and controlling costs. If the average pretax profit margin exceeds that of the last 5 years, consider that company as the best.

3. Return on Equity

Find out the amount of money the company has generated in revenues with the money invested by shareholders. To calculate this number, divide the net income by the shareholder equity. The best practice to follow is to compare this value with the data from the past 5 years. If the figures are stable or greater, it signals that the company is performing well. 

4. Forward Earnings Growth

A public statement of their profit for a specific period is released by a company every quarter or a year. These figures offer a great opportunity to analyse a company’s performance and to check whether a company is accountable in terms of profit. They help the investors in finding out which companies have chances to grow above the average and current rates. 

5. Stock Performance

Last but not least, another factor to consider in growth investing is the stock performance. If a company’s stock is performing well and is doubling in the next 5 to 7 years with at least 10% growth, that company qualifies for growth investing.

Benefits of growth investing

A major advantage of investing in growth shares is the potential for higher share price returns if the companies find success in achieving above-average earnings growth. In addition to that, when the economic conditions are favourable, growth shares tend to outperform as the investor confidence will be high.

Risks in growth investing

When interest rates go up, it badly affects the performance of growth shares. One more scenario is an economic downturn as investors may de-risk their portfolios by reducing their holdings of growth shares. Due to this reason, there will be downward pressure on share prices. Also, growth shares are more volatile and investors will be having huge expectations of earnings growth. In case the company fails to achieve forecast earnings, it will end up in a significant fall in share price.

Key takeaways

• In Growth investing, the focus is on companies that are expected to grow faster than the market average.
• The 4 main features of growth investing are targeting high-revenue, rapidly-expanding businesses, better price-to-earnings (P/E) ratios, focus on innovation, scalability, and expansion and suitable for those with higher risk appetite and long-term horizon.
• 5 factors to consider in growth investing are historical growth, profit margins, return on equity, forward earnings growth and stock performance.
• The major benefits of growth investing are the potential for higher share price returns if the companies become successful in achieving above-average earnings growth and the chances of outperformance during favourable economic conditions.
• The major risks include poor performance during rise in interest rates, downward pressure on share prices in an economic downturn and a major fall in share price if the company fails to achieve forecast earnings.

Parting Words

Want to try your hand at growth investing? It becomes more effective when you get trained from a trusted platform, under an expert mentor. Entri Finacademy is one such finance education platform with over 9 million students and a team of highly experienced expert mentors. Since 2022, Entri has been offering stock market courses and has grown to be the market leader. The best part is that here you get an opportunity to learn stock markets right from the very beginning to the advanced level. Moreover, there is the option to learn stock market courses in several regional languages, including Malayalam. To know further about Entri Finacademy’s stock market courses, click here.