7 rules of Growth Investing

It will be better to compare growth investing with value investing in order to define it. Value investors look for stocks which are trading for less than intrinsic value today,whereas growth investors focus on the future potential of a company, with much less emphasis on the present price. Growth investors try to increase their wealth mainly through long term or short investments.Learning about the stock market will help you understand about this style of investment.

What is Growth Investing?

Growth investing is a style of investment strategy focused on increase in price or value of assets. Those who follow this strategy are known as growth investors that focus on future potential of company, with less emphasis on present price. It is often called capital growth strategy because investors seek to maximize their capital gain.

Profits from Price appreciation – not dividend       

Growth investors invest in companies whose earnings are expected to grow in comparison to its industry or overall markets. As a result growth investors focus on companies with huge growth potential. The idea behind growth investing is that growth in earnings or revenue will translate into higher stock price in future. Growth investors look for investments in rapidly expanding industries where new technologies and services are being developed and earn profit through stock appreciation and not dividends. Growth investing is highly attractive to many investors because buying stock in growth companies can provide impressive returns if the companies are successful. However, such companies are highly risky.

Source: wela financial blog

What to look for in Growth Investing?

There is no hard and fast rule for evaluating this formula; it requires a degree of individual interpretation and judgement. Growth investors use certain guidelines or criteria as a framework for their analysis, but these guidelines must be applied with a company’s particular situation in mind, which means investors must consider the company in relation to industries’ past performance compare the company’s particular situation in mind.

The application of any guideline or criterion may therefore change from company to company and from industry to industry.  Some general guidelines one might include as part of their growth investing strategy would be to look for companies with:

• Increase in quarterly sales (YoY): It means an increase in sales for any quarter in comparison to same quarter in previous year. This gives an idea of how much sales of the company are increasing overtime (i.e. its quarterly sales growth).

• Consistent sales growth ratio annually: This parameter will select stocks whose sales growth rate are consistently increasing every year. It is a sign of financial health of a company, where companies are offering new products or services, diversification of its business with change in technologies, fulfilling customer’s needs, etc in order to maintain its brand image.   

• Quarterly EBITDA growth YoY: EBITDA of the company does not take into account Interest, Taxes, depreciation and amortisation. It gives investors a clear view of company’s operating profitability (i.e. how much cash company is generating from its business).

• Quarterly net profit growth YoY: Quarterly growth in net profit indicates that company is able to generate profit after deducting all the expenses from its revenue. Growth in the same indicated that company is able to maintain its market and is growing.  

• Consistently increasing quarterly EPS: It means company’s EPS for the quarter is being compared to the previous quarters. It is also called net income per share, measures the amount of net income earned per share of outstanding stock.

• Consistently increasing annual EPS: It means company’s EPS for the year is being compared to the previous years. It is also called net income per share, measures the amount of net income earned per share of outstanding stock.

• Increasing Cash flow from operations: It signifies the financial strength of the company due to an increase in earnings. It means that after all the direct costs related to production and distribution of goods is deducted from sales the company generates enough cash from operations.

Bottomline

Investors have many options and ways to execute a strategy that focuses on capital appreciation which includes investing in blue chip companies, investing in smaller companies having high growth potential, investing in emerging markets, etc. Warren buffet has recognised the value of growth investing through his business partner Charlie Munger which is expressed by Buffet’s saying:

“It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price”