Find out how Growth Investing technique works.
Identifying stocks with above-average growth rates yields long-term returns
Investing in growth is a rather idiosyncratic approach. Unlike value-investing where you abide by the 'buy low, sell high' philosophy, a growth approach relies upon identifying companies with sustainable growth projections, which should equate to a sustainable, appreciating stock price over the long-term.
This technique suits traders with a longer-term investment horizon (minimum of three years), as 'growth stocks' are expected to appreciate at a faster rate than their industry peers or the overall market over the same period.
Three types of popular growth investors:
The small-cap investor: Probably the simplest and most well known type of growth investor. Small-cap investors buy listed companies with a relatively small capitalisation in the market in the expectation that investing in a 'gazelle' company, with high-growth projected, its potential valuation is underestimated in today's market.
The IPO investor: This type of investor aims to subscribe to upcoming new share issues from companies listing on the stock market for the first time, which have displayed strong growth prospects and financial backing from the banking community.
The young growth investor: This type of investor takes positions in young growth companies (even before they make a profit and pay dividends) purely based on the expectation that these companies have stunning and compelling growth prospects irrespective of their financial position to date. As it sounds, this is a high-risk strategy but for young growth stocks in some sectors, such as technology, the lack of a pre-existing market for their product or service does not mean an innovative company cannot become highly valued in the future. This is what young growth investors are speculating on.
Identifying Growth stocks
Typically, growth stocks do not tend to pay a dividend but exhibit signs of above-average growth, even if their share price appears expensive in terms of valuation.
Growth investors use metrics such as price-to-earnings (P/E) or price-to-book (P/B) ratios to assess whether the stock has a sustainable growth path. Typically, growth stocks trade at high P/E and P/B ratios with rising sales, solid profits and ambitious earnings prospects, all major characteristics.
This involves extensive and thorough fundamental research into a company before purchasing its stock; a challenging task for any investor.
Stock-screening is absolutely essential in this approach as you are seeking long-term growth based upon the current information you have. In order to find stocks ripe for the picking, you must conduct intensive fundamental research into a company, its industries and markets.
To help you be successful, you must make accurate estimates of a company's growth rates and profitability well into the future. At the same time, you must assess whether the company can continue to exceed market expectations with its future financial performance, which lead to an appreciation of the company's stock price.
That however, can be a big risk, as it assumes that the stock price and the company's growth are directly linked, which is true only under specific circumstances and certainly not in all cases. That is it is absolutely imperative that your financial forecasts for a company's growth potential must be spot-on.
Intensive investment research
To help you be successful with your stock picks, you would need to undertake a substantial amount of research about companies before you can invest in them. This can prove challenging as it involves using current information to produce near-accurate predictions of the future.
High volatility in growth stocks
Growth stocks can be highly volatile by nature with stock prices rapidly gaining astronomically high values and losing them just as quickly. That is because many growth stocks have high P/E ratios which mean these companies are vulnerable to wild swings in value.
Long term investment
Growth investment is a long-term technique for investors who are comfortable in hanging onto their stockholding for years or even decades. If you are the type of investor who likes to realise immediate profits and to trade on a day-to-day basis, this is not the approach for you.
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