Growth investing: The complete guide for beginners
Growth stocks have shown significant returns over the past decade. Get to know whether a growth investing strategy is right for you and how to implement it.
What is growth investing?
Growth investing is an investment strategy focused on investing in companies that are expected to experience above-average growth in their earnings or revenues. The primary objective of a growth investor is to achieve capital appreciation over the long term by identifying and investing in stocks of companies that have the potential for significant growth in their market value.
Growth investors typically seek out companies that are in the growth phase of their business lifecycle, such companies are characterised by expanding market share, innovative products or services, and strong financial performance. These companies may operate in industries such as technology, biotechnology, e-commerce, cyber security, artificial intelligence or other sectors with high growth potential.
Key characteristics of growth investing
- Revenue and earnings growth: Growth investors look for companies that demonstrate consistent revenue and earnings growth. They analyse historical financial data and projections to assess the company's growth potential.
- Competitive advantage: Growth companies often have a competitive advantage over their peers, such as unique technology, a strong brand, or intellectual property that gives them a significant edge in the market.
- Market expansion: Growth investors focus on companies operating in expanding markets, as these provide opportunities for higher revenue growth. They evaluate the market size and potential demand for the company's products or services.
- High valuations: Growth stocks are often associated with higher valuations compared to their earnings or book values. Investors are willing to pay a premium for the growth potential of these companies, which can result in higher price-to-earnings (P/E) ratios.
- Volatility: Growth stocks can be more volatile than value stocks due to high expectations and market sentiment. The stock prices of growth companies may experience significant fluctuations, presenting both opportunities and risks for investors.
How do you determine a growth stock?
Here are some key steps to determining whether a company's stock could be considered a growth stock:
Assess financial performance
- Analyse historical financial data: Look for companies with consistent revenue growth over the past few years. Check if the company has been able to grow its earnings at a faster rate than the industry average.
- Evaluate profitability: Examine profit margins and return on equity (ROE) to ensure the company is generating healthy profits and effectively utilising its shareholders' equity.
- Consider cash flow: Evaluate the company's cash flow statement to ensure it generates strong cash flows from its operations.
Evaluate market opportunity
- Identify a growing industry: Determine if the company operates in an industry with favourable growth prospects. Look for trends, market size, and potential demand drivers.
- Assess the competitive landscape: Evaluate the company's position within its industry. Look for a competitive advantage, such as unique products or services, strong brand recognition, or technological innovation.
- Consider market share: Determine if the company has the potential to gain or increase its market share. Look for signs of successful market penetration or expansion plans.
Research innovation and expansion
- Evaluate R&D investments: Analyse the company's commitment to research and development. Look for evidence of ongoing innovation, new product development, or technological advancements.
- Assess expansion plans: Determine if the company has strategies in place to expand its operations geographically or enter new markets. Evaluate its ability to execute these plans successfully.
Analyse management and leadership
- Evaluate management quality: Assess the experience, track record, and expertise of the company's management team. Look for a history of successful execution and their ability to navigate growth challenges.
- Review corporate governance: Consider the company's governance structure, board composition, and alignment of management's interests with shareholders. Look for transparency and accountability in corporate practices.
Growth investing vs value investing
Growth and value stocks tend to be pretty different, but they also share some similarities. Check out below the main characteristics of value investing and growth investing.
Focus on companies with strong growth potential and higher expected future earnings.
Focus on companies that are undervalued compared to their intrinsic value or the value of their assets.
Emphasis on revenue and earnings growth rates.
Emphasis on the company's assets, including book value and tangible assets.
Often invest in companies in the growth phase of their business lifecycle.
Often invest in companies that may be temporarily out of favour or facing challenges, but have potential for a turnaround.
Tend to have higher valuations, reflected in higher price-to-earnings (P/E) ratios.
Tend to have lower valuations, reflected in lower price-to-earnings (P/E) ratios.
Look for companies with a competitive advantage, innovative products or services, and expanding market share.
Look for companies with solid fundamentals, stable cash flows, and a margin of safety in their valuations.
Focus on industries and sectors with high growth potential, such as technology, biotechnology, or e-commerce.
Focus on industries and sectors that may be out of favour or undervalued, such as traditional manufacturing or mature industries.
Higher volatility due to market expectations and sentiment.
Lower volatility due to a more conservative approach and focus on intrinsic value.
Investment horizon is typically longer-term to capture the growth potential.
Investment horizon can vary, but may also be longer-term as investors wait for the market to recognise the company's value.
🎓 Learn more: How to know if a stock is undervalued or overvalued?→
How to invest in growth stocks?
- Find a stock investing platform: To buy growth stocks, you'll need to sign up to a broker with access to the stock market. There are a number of share trading platforms in Australia, of which Stake is one.
- Fund your account: Complete an application with your personal and financial details. Fund your brokerage account with a bank transfer, debit card or even Apple/Google Pay.
- Search for the growth stock: Find the share by name or ticker symbol. Do your own research to ensure it is the right investment product for your own circumstances.
- Choose an order type and buy the desired shares: Buy on any trading day with a market order, or use a limit order to delay your purchase of shares until it reaches your desired stock price. Look into dollar cost averaging to spread out your risk, which smooths out buying at consistent intervals.
- Monitor your investment: Optimise your portfolio by tracking how your stock and the business perform with an eye on the long term. You may be eligible for dividends and shareholder voting rights that affect your stock.
✅ Looking for growth stocks to invest in? Sign up today and find them on the Stake app.
What is the risk appetite of growth investors?
The risk appetite of growth investors can vary, but generally, growth investors tend to have a higher risk tolerance compared to other types of investors. Here are some key characteristics of the risk appetite of growth investors:
- Comfort with volatility: Growth investors are typically more comfortable with market volatility and the potential for short-term price fluctuations. They understand that growth stocks can experience significant ups and downs and are willing to endure the inherent volatility for the potential of higher returns over the long term.
- Focus on long-term growth: Growth investors have a longer-term investment horizon and are willing to hold their investments for an extended period. They are less concerned with short-term market movements and more focused on the growth potential of the companies they invest in.
- Acceptance of higher valuations: Growth stocks often trade at higher valuations, reflected in higher price-to-earnings (P/E) ratios. Growth investors are willing to pay a premium for companies they believe have strong growth prospects, even if it means the stock is relatively more expensive compared to its current earnings.
- Willingness to invest in emerging industries: Growth investors are often attracted to emerging industries or sectors with high growth potential. These industries may carry higher risks due to factors such as regulatory uncertainties, technological disruptions, or unproven business models. Growth investors are willing to take on these risks in pursuit of potentially higher returns.
- Greater risk diversification: Growth investors may diversify their portfolios across multiple growth stocks and industries. While they accept higher risks, they also understand the importance of diversification to manage risk. By spreading investments across different companies and sectors, growth investors aim to mitigate the impact of any individual stock's performance.
- Active monitoring and research: Growth investors tend to actively monitor their investments and stay informed about market trends, company developments, and industry dynamics. They conduct thorough research and analysis to identify potential growth opportunities and are proactive in managing their portfolios.
It's important to note that the risk appetite of people investing in growth shares can vary among individuals. Some growth investors may have a higher risk tolerance and actively seek out high-growth, high-risk opportunities, while others may take a more balanced approach by combining growth stocks with other investment strategies to manage risk.
Is a growth investing strategy right for you? Here are the growth investing pros and cons
- Potential for high returns: Growth stocks have the potential for significant capital appreciation over the long term. Investing in companies with strong growth potential can lead to substantial gains if the growth expectations are realised but the risk of these types of stocks is generally increased.
- Alignment with market trends: Growth investing focuses on companies operating in industries or sectors with high growth potential. By investing in these companies, you align your portfolio with broader market trends and emerging opportunities.
- Investing in innovation and disruption: Growth stocks often represent innovative companies that are driving technological advancements or disrupting traditional industries. Investing in these companies allows you to be part of the transformative changes happening in the business world.
- Long-term wealth creation: Growth investing is typically a long-term strategy, which aligns with the goal of long-term wealth creation. By identifying and investing in companies with sustainable growth prospects, you have the potential to accumulate wealth over time.
- Volatility and market risk: Growth stocks can be more volatile than other types of investments. The high growth expectations and market sentiment can lead to significant price fluctuations. Investors should be prepared for short-term volatility and potential downturns in the market.
- Valuation concerns: Growth stocks often trade at higher valuations, with higher price-to-earnings (P/E) ratios. There is a risk of overpaying for growth, and if the growth expectations are not met, there can be a sharp correction in the stock price.
- Limited dividend income: Growth companies often reinvest their earnings back into the business to fuel further growth. This means they may not pay significant dividends to shareholders. If you rely on dividend income, growth stocks may not be the best choice for generating immediate cash flow.
- Growth expectations not always met: Not all growth companies achieve their projected growth rates and future earnings growth disappoints. Factors such as increased competition, economic downturns, or industry disruptions can impact a company's growth trajectory. Investing in growth stocks requires careful analysis and the ability to evaluate potential risks accurately.
This does not constitute financial product advice nor a recommendation to invest in the securities listed. Past performance is not a reliable indicator of future performance. As always, do your own research and consider seeking appropriate financial or taxation advice before investing.
Megan is a markets analyst at Stake, with 7 years of experience in the world of investing and a Master’s degree in Business and Economics from The University of Sydney Business School. Megan has extensive knowledge of the UK markets, working as an analyst at ARCH Emerging Markets - a UK investment advisory platform focused on private equity. Previously she also worked as an analyst at Australian robo advisor Stockspot, where she researched ASX listed equities and helped construct the company's portfolios.