Why do we invest? The obvious answer is to grow money. Investing money yields monetary appreciation, and that’s the primary purpose of why we invest. However, not everyone has the knowledge and required skill sets to begin investing. The reason is that the investment space is more profound than what you perceive it to be, with numerous instruments and styles to invest money.
If you are wondering what investment styles are, let us simplify this. Growth investing, value investing, trend investing, etc., are a few styles of making your investment choice. The ultimate goal of these investment methods is to compound your money.
Just like you have your own favorite food dish, once you start investing, you will find your preferred style, too. For this article, let’s take a step towards learning what growth investing is and how you can pick investments based on this! Let’s get started.
What Is Growth Investing?
There are many options to grow your money. You can invest and earn interest from your savings accounts, fixed deposits, bonds, or equity investments based on your investment profile and risk tolerance level. However, not all these investments are considered a part of growth investing.
Growth investing refers to investing money in assets that showcase growth above the overall market growth. These assets can be stocks, cryptos, currencies, and so on; however, stocks are more popularly used for the term growth investments.
Growth investors focus on the company’s growth potential at a particular rate with less weight to the current price. It is also known as a capital growth strategy, as investors try to maximize their capital gains.
Growth companies are generally defined as having high P/E (Current price / EPS), P/B (Current Price / Book value per share), and lower dividend yield ratio (Dividend / current price).
Theoretically, these parameters define growth investments. However, know that this is not a thumb rule, and you should consider other factors as well.
For example, Portfolio X consists of two stocks. The first stock has given a return of 20%, and the other one has yielded 12% during a raging bull market where the benchmark index gave a 15% return. Here, the first stock with a higher return is a growth stock, and another stock might be a defensive stock.
However, you must keep in mind that the company might underachieve or not achieve the desired growth rate, and a disclaimer should flash in your mind that investments in stock markets are risky and subject to your own analysis.
What Are the Types of Growth Investments?
The below category of investments has historically shown characteristics of growth investments. However, this should be taken with a pinch of salt, as without research, investments are no different than gambling. You should only invest if the investment aligns with the risk and return profile as well as your objectives.
1. High-yield stocks
Stocks in this category are in their initial phase of growth and have the potential to grow at an exponential rate. These stocks have historically outperformed their peers and still have room to compound earnings at a higher rate. The reasons for this acceleration could be pricing power, product differentiation, innovation, increasing market share, etc.
However, with more return, you should also focus on risk factors and volatility. Large company stocks are typically considered high-yield stocks subject to their performance.
2. Sector-based mutual funds and exchange-traded funds
Mutual funds and ETFs are an excellent way for investors to ride the growth theme. They invest in sectors that have growth potential. These instruments invest in specific sectors or industries to leverage their programs. Two such ever-green sectors are technology and healthcare. Investing in MFs and ETFs that invest in these two sectors can be counted as growth investing.
After the pandemic, we have seen a surge in the demand and production of new technology and related products. Companies developing new technologies and disrupting existing markets are a good play for the growth theme. In a similar way, the healthcare sector has also boomed post-2019. These companies have the potential to compound their earnings at a higher rate and thus follow the category of growth stocks.
However, you should keep in mind that markets move in cycles and some sectors outperform others depending on the cycle. As an investor, before jumping into risky endeavors, you must do due diligence on the overall economy, sector, and growth fund or ETF you wish to invest in.
3. Other investment options
While stocks are more prominent growth investment options, other investments include options like cryptos, forex, penny stocks, commodities, options, etc. Depending on their performances, these investment options can be included in your portfolio to ride the tide of growth investing.
They have their own pros and cons, and you need to learn how they function. Also, these investments come with risks and should be considered after conducting proper research and analysis.
What to Consider Before Indulging in Growth Investing?
There is no defined formula or framework to segregate investment options into this category; it depends on the degree of individual interpretation and decision-making. Below is the list of parameters to help you get started with growth investing.
1. Sales growth rate
This parameter looks for the companies where sales growth is consistently growing year over year and quarter over quarter. Sales are like the headline number, which shows the company’s strength and financial health.
A company selling more innovative products and offering new products and services to cater to market needs has higher sales. However, the biggest challenge is maintaining sales growth and keeping innovating at the forefront. Investors generally compare sales figures over the previous quarter and year to make investment decisions.
2. Net income growth rate
This parameter indicates whether the company can generate profit after deducting all the expenses. Net income growth is very vital as a metric, as it comes in many ratios that measure the financial health of a company. Growth in the net income indicates that the company can generate sufficient cash flows while maintaining market share.
Net income can be found using the formula:
Net Income = Sales – COGS – SG&A – Depreciation & Amortization – Interest – Taxes
For a comprehensive analysis, net income growth is compared with the previous quarter and year.
3. EBITDA growth rate
EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization. This is the company’s earnings before factoring in all the parameters mentioned above. It gives investors a view of the company’s operating profitability as recurring and non-recurring expenses are already deducted. Like other metrics, EBITDA is also compared with the previous quarter and year for better analysis.
4. EPS growth
Earning Per Share is earnings per share and is found out by dividing earnings by the number of shares outstanding. This can easily be found in any of the public databases.
EPS is a crucial metric as it shows how much earnings a company can earn on a per-share basis. The higher the number, the better it is. Growth investors look out for companies having positive EPS growth over the previous quarter and year.
5. Cash flow from operations
This is the most critical metric in deciding whether a stock is a growth stock or not. Cash flow from operations shows how much cash flow a company can generate with the core operations. It signifies the financial muscle of the company, and its growth gives more confidence to investors.
Cash flow from operations can be found if you analyze the structure of the cash flow statement of any company. Variables like net income, depreciation, interest expenses, tax rate, etc., come into play to determine cash flow from operations.
You need to consider the above metric to identify growth investment options and how they progress over the years.
How Is Growth Investing Different From Value Investing?
There has always been a debate between these two styles of investments. While markets move in cycles, every style has its own edge in the market at a particular time. Growth stocks tend to exhibit higher growth and volatile price movements, and value stocks, on the other hand, are stable and take their own pace to grow. Value stocks don’t exhibit higher volatility and generally have a good track record of paying dividends. They tend to be comparatively stable and are considered a good hedge during turbulent market movements.
As a rule of thumb, growth stocks exhibit higher P/E, P/B, and lower dividend yields ratio, and value stocks, on the other hand, are low P/E, P/B, and higher dividend yield stocks.
We cannot talk about value investing without talking about Warren Buffet–the pioneer of investing who made his wealth by investing in good value stocks. Investors who want a stable income in the form of dividends generally prefer value stocks, whereas growth stocks reinvest their earnings in growth projects and have lower to no dividend yields.
Value stocks are not that sensitive to market news and movements as compared to growth stocks.
The final question is, which strategy is better? The answer to that depends on your investment requirements and goals. Only you can decide which kind of companies you want to include in your portfolio, depending on your investment profile.
The Bottom Line
A stock market is where investors gather and trade the stocks they find suitable. As an investor, you have to decide which investment style and strategy suits you based on your risk and return objectives. The bottom line is – Invest in the companies that align with your goals and whose businesses make sense to you. Growth investing is an excellent investment style to explore and compound your capital at a higher rate if you do proper due diligence. With practice, you can also expand it to other investment options like cryptos, ETFs, too,
FAQs
1. What is the 5% rule in investing?
The 5% rule in investing refers to the fact that an investor should refrain from allocating more than 5% weight to a single asset or investment option. This ensures that the concentration risk is minimum and the portfolio is well-diversified to reduce the adverse effects in times of crisis.
2. What is the risk of growth investing?
While there are no upfront risks of investing in growth investment options, it is a shortfall that they do not offer dividend income as value investment options do. Thus, if an investor wants to profit, he has to sell the shares. If the investment is not performing well during that particular time, it can result in a loss. Thus, it is always advisable to invest after doing thorough research, whether it’s growth investing or value investing.
3. Should I invest in value or growth?
The answer to this question depends on your investment goals and preferences. If you wish to earn regular dividends, you can go for value investing. However, if you wish to leverage growth via investing in companies expanding and exploring new avenues, you can choose growth investing. It is on you to decide which style suits you best.
