A growth investing strategy involves investing in small or new companies that are expected to grow faster than average. The idea is that your investment will grow faster than the overall market — or even the industry sector the companies are a part of.
What Is Growth Investing?
Growth investing is a strategy focused on buying stocks that are expected to grow faster than the overall market. It often involves investing in small or new companies — typically firms in emerging markets or those involved in creating innovations in their industry sector.
A growth investing strategy offers the opportunity for higher returns on your investment. But it also involves higher risk.
- The company has a record of high earnings growth.
- Stocks tend to be priced higher than average across the market.
- Stocks in the company tend to be more volatile than stocks across the broader market.
Growth investing usually involves equity — how much value you own after all debts are covered. Most forms of growth investing can involve high risk, but there are ways to minimize it. This usually involves spreading your investments across multiple companies.
- Growth funds
- These are mutual funds that include stock from a wide range of companies that meet the definition of growth companies. They include many of the advantages of growth investing while minimizing risk to the investor.
- Technology and health care stocks
- These companies tend to be in the business of innovation, which can sometimes result in exponential growth in a short period of time.
- Small-cap stocks
- Small capitalization stocks are shares of companies with a market capitalization between $300 million and $2 billion. Companies in this range tend to be young firms with the potential for growth.
- Speculative investing
- This growth investing strategy can result in extremely large returns but can also carry the most catastrophic risk — losing all of your initial investment. These include foreign currency, penny stocks, futures and options trading, oil- and gas-drilling projects and certain real estate development projects.
Growth investing differs from value investing, which is a strategy of buying stocks that seem to be trading for less than their actual value. It also differs from dividend investing, which involves investing in mature companies that produce revenues far exceeding their costs and paying large dividends to investors.
What Are Growth Funds?
The most common way to follow a growth investing strategy is to invest in growth funds. These are mutual funds or exchange-traded funds (ETFs) that focus on companies with high growth potential.
Growth funds are diversified portfolios of stocks that typically pay little to no dividends. Instead, the companies tend to plow their earnings back into their business to fuel growth.
They allow you to spread your investments across multiple growth companies, increasing your potential for return while lowering the risk you’d experience investing in a single company.
However, they still involve risk to your investment. Growth funds are best suited for investors who are able to embrace risk and willing to face volatility in the market.
- Alphabet (Google)
In addition to typical growth stocks, there is also a category known as emerging growth stocks. These are shares of companies that have the potential for high rates of growth but have yet to establish a history of that growth.
How to Invest in a Growth Fund
You can purchase a growth fund through an investment company; a financial services company that handles investments; a brokerage, including an online broker; or from the company that created a particular fund.
Most employer-provided 401(k) plans offer an aggressive growth fund as one of the most common types of mutual funds available.
Online brokers may offer a wide variety of growth funds, as well as online tools to help you research your options.
- Affordable fees
- Check transaction fees and other costs or expenses carefully.
- The number of options vary widely by broker or your 401(k) from a few choices to hundreds or thousands of choices with large brokers.
- Online options
- Digital brokers often come with digital tools, but make sure they’re easy to use and provide the information you need.
Finding and Researching Fast Growth Investments
Finding companies that pay off in a growth investing strategy requires careful research of a company’s viability, business practices, service or product offerings and level of competitiveness.
Even if you invest in a growth fund through your employer’s 401(k) plan, you should research the holdings of the funds you choose.
- Stock performance
- The company’s stock should have a strong potential to double in five years to be considered a growth stock. Remember, this simply means that stock prices should rise by 15 percent each year to reach that doubling in five years.
- Earnings per share (EPS)
- Typically, a good growth stock will show increasing earnings on each share of stock over time. Affirm that the increase is due to cash flow from actual business activities. Companies should show a record of strong earnings growth over the previous five to 10 years.
- New and fast-rising sectors
- Companies in sectors of the economy that outperform the market overall are more likely to have growth investing potential. It’s important to understand what a company is doing and how it fits into its sector.
- Projected earnings
- If a company announces projected earnings that are higher than expected, stock prices can rise quickly and return to original levels in the days immediately afterward. But if you are investing for the long run, you want to make sure the company has a solid record of positive projected earnings reports that help the stock price rise consistently over time.
- Quality of senior management
- Research the experience and past performance of the company’s board of directors and executives. The weight of their experience and their track records can give you an idea of how risky an investment the company is in the long haul.
- Return on assets (ROA)
- This measure of how profitable the company is relative to its total assets can give you an idea of how efficient the company’s management is at using assets to generate profits. ROA is expressed as a percentage, with a higher percentage being better. The ROA is determined by dividing the company’s net income by its total assets.
- Return on equity (ROE)
- This is a percentage that shows how efficiently a company can make a profit. It’s calculated by dividing the company’s net income by the total equity of its stockholders. The higher the percentage, the better.
- Future earnings potential
- Assessing a company’s ROA and ROE along with its current assets, profits and revenues can help you get an idea of potential ability to generate profits in the long term.
Other factors to consider when researching companies for a growth investing strategy include strong profit margins, earnings estimates and earnings announcements. These are typically quarterly and annual reports.
6 Cited Research Articles
- Chandler, S. (2020, November 24). What Is Growth Investing? A Strategy that Focuses on High-Growth Companies in Hopes for Significant Investment Returns. Retrieved from https://www.businessinsider.com/growth-investing-definition-strategies
- Chang, E. (2019, September 3). Pros, Cons of Investing in Growth ETFs. Retrieved from https://money.usnews.com/investing/funds/articles/pros-cons-of-investing-in-growth-etfs
- Kalkin Media. (2018, December 22). Pros & Cons of Investing in Growth Stocks. Retrieved from https://kalkinemedia.com/au/blog/pros-cons-of-investing-in-growth-stocks
- Samant, K. (2018, October 11). Growth Funds. Retrieved from https://www.orowealth.com/insights/blog/growth-funds/
- Merrill. (n.d.). Growth vs. Value: Two Approaches to Stock Investing. Retrieved from https://www.merrilledge.com/article/growth-vs-value-investing-two-approaches-to-stocks
- Fidelity. (n.d.). 2 Schools of Investing: Growth vs. Value. Retrieved from https://www.fidelity.com/learning-center/investment-products/mutual-funds/2-schools-growth-vs-value