Growth investing is about putting your money into companies you think will make greater profits in the future. It is usually considered the flip-side of value investing.
Most viable listed companies will grow profits over time, so a growth investor is looking for companies that are expanding their profits faster than rivals or the market.
Growth investors [1] aim to make capital gains from a higher share price, as opposed to for example buying dividend paying shares [2] for income.
The very best growth stocks can deliver returns of a hundredfold or more after decades of growth, although by definition only a tiny handful of the thousands of companies listed will ever reach blue chip status.
Most growth shares fizzle out long before they trouble the top of the index:
- Sometimes a growth company slows down to become just another staid performer (also known as going ‘ex-growth’). This outcome can still make you excellent returns if you got into the share early enough.
- Other would-be growth companies die trying.
- My personal bugbear is when growth companies are acquired when still young and with all their potential ahead of them. This happens quite often; if you can see the potential in a company, so can industry rivals.
Even when a growth share does go all the way from small cap growth stock [3] to international giant, few investors stay aboard for the entire ride. Owning a successful growth share is a dizzying experience!
Growth investing is hard. Much more common than finding a Microsoft is buying a ‘jam tomorrow’ share, that promises much but never delivers.
This reached its zenith in the Dotcom boom, when companies were growing sales or market share but weren’t growing profits, or even making any money at all.
While all growth investors will inevitably put more emphasis on the business story and the potential for expansion than a value investor, sensible growth investors look at cashflow and return on capital employed to see how the company is multiplying their investment.
Finally, it’s worth noting that some investment greats like Warren Buffett [4] and Peter Lynch argue it’s a mistake to think in terms of value or growth shares.
Buffett espouses the idea of ‘intrinsic value’ instead.
However as a convenient way of labelling an investing method that focusses on profit growth as opposed to value investing’s emphasis on under-rated assets [5] or performance, the growth investing label is useful and here to stay.