What is Growth Investing?

Definition:

The term (high) growth investing describes an investment strategy in which investors invest specifically in companies or shares with above-average growth potential.

While value investors invest in companies that have already proven that their business model is successful and profitable, growth companies are often companies with a lower market capitalization, which have not yet reached their full potential and are in some cases not yet profitable or have just made the step to profitability.

Key takeaways:

  • Growth investors look for growth stocks with very high upside potential.
  • Yields of several thousand percent in a few years are possible.
  • Growth stocks are often very volatile (high risk).
  • Growth Investing is more suitable for speculative investors or as part of an overall portfolio.

For whom is Growth Investing suitable?

Every shareholder wants the share prices of the companies in his own portfolio to rise sharply. The statement “Growth Investing is an investment strategy for shareholders who are looking for price increases” therefore makes little sense.

The price potential of a share must be put in relation to the risk and there must be an awareness that growth shares can be very volatile in principle and that in the worst case a company may have to file for bankruptcy.

Value shares are therefore often better suited for buy and hold than growth shares. Ideally, a growth share becomes a value share in the long term. An example of such a case would be Apple.

However, investors must consciously accept very high possible (interim) price losses, or pursue a strategy in which a possible loss in the share price is hedged, for example by a stop loss or a put option.

In addition, it is usually advisable to view growth investing as one component of an overall portfolio that can be combined with more conservative investment strategies.

To summarize again, Growth Investing is suitable for:

  • for active private investors
  • for investors with high risk tolerance
  • for investors with good analytical skills and a feel for future trends
  • as part of a portfolio

Characteristics of growth stocks

What makes growth stocks stand out:

Innovation

Growth stocks are often young companies that are developing new market segments and/or offering new and innovative products and services that have not yet established themselves on the market in the long term. In the last 20-30 years, this has been the case, for example, with many tech companies that were initially considered growth stocks and are now profitable and established companies, such as

  • Apple
  • Goolge
  • Netflix
  • Facebook
  • Ebay
  • Amazon
  • etc.

High P/E ratio

According to classic valuation criteria, growth stocks are often already considered expensive (e.g. high P/E ratio, high CVA) before a (further) massive price increase follows. I.e. a high P/E/E ratio, which can serve as an exclusion criterion for a value investor, is not a reliable indicator for a growth company, since the future price increase is justified by above-average sales growth (and profit growth).

No dividends

While supporters of a value or income strategy see continuously rising dividends as a quality criterion, growth stocks often do not pay a dividend. Instead, every cent of the profit is reinvested immediately. The motto is: growth, growth, growth.

Great opportunities & great risk

There’s no such thing as free in the stock market. A high profit potential often means a high loss potential at the same time. There are many companies that were once considered hopeful growth companies and benefited from a certain hype (e.g. 3D printing shares, see below) and ultimately suffered enormous losses.

Even for companies that made it, the road was often rocky. Apple, for example, suffered several times a 50 – 80 % slump, which would probably have led to doubts and possibly sales even for a hard-boiled growth investor.

Another good example of a company where the fight between bears and bulls could be observed well in the recent past and where the media was caught between certain bankruptcy and high-flyer of the next years is Tesla. Here, too, a glance at the chart reveals relatively high volatility.

Examples of growth stocks

Typical behaviour of growth stocks

Below you will find some examples of shares that were/are considered growth shares. It becomes clear that the positive examples also show that as an investor you have to expect high volatility.

In the case of Stratasys and 3D Systems you can see what can happen when one industry (in this case the 3 Print) is experiencing a big hype and investors don’t want to miss the next big trend, but the “bet” doesn’t work out.

Netflix

Netflix has grown in recent years from a small unknown online video store to one of the most popular and well-known streaming providers and series producers. With the worldwide triumph of Netflix, the stock also experienced an enormously positive development. From the all-time low to the all-time high, the performance is about 100 000 % (from a few cents to over 400 USD).

A glance at the chart shows the typical very volatile behavior of growth stocks, especially in the first few years.

Apple

Another high flyer of the last 20 years is Apple. The company has brought numerous new and revolutionary products to the market. But here too, investors needed strong nerves in the beginning. Those who dared to buy shares of Apple at the time of the release of the first iPhone, after the shares had risen by more than 3000 % in the years before, could still make a very good deal, but also had to cope with a significant drop in the share price during the financial crisis.

Tesla

One company and stock that has led to a very strong polarization in recent years among both private investors and institutional market participants is Tesla. In the media, too, the company has moved between bankruptcy and the coming global market leader in the automotive industry. In 2019, the bears lost the race and an enormous short squeeze followed, catapulting the share from under USD 200 to almost USD 1000.

As examples from other growth companies show, despite the already very good performance of Tesla’s stock, it cannot be ruled out that the stock will at best multiply again in the next few years.

3 D Systems

The example of the 3D printing industry shows what can happen if the hoped-for revolution fails to materialize and a company or industry is not able to assert itself to the extent that the stock market trend would suggest.

The stock of 3D Systems, one of the market leaders in the industry, has moved from less than 10 USD to about 100 USD and back again within 5 years.


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