Stocks 1 Section7 Lessons2 Weeks
Lesson 5: Introduction to Growth Investing
The Growth Investing Philosophy
Growth investing focuses on companies that are expected to grow at an above-average rate compared to the overall market or their industry.
Core Principle: Invest in companies with strong potential for future expansion, even if their current valuations seem high.
Characteristics of Growth Stocks
1. Rapid Revenue and Earnings Growth
Growth companies are expanding quickly, often at 15%+ annually.
2. High Reinvestment
They typically reinvest most or all profits back into the business rather than paying dividends.
3. Innovative Products or Services
Often operate in new or rapidly evolving industries.
4. Higher Valuations
Typically have higher P/E ratios because investors are paying for future growth.
Key Growth Investing Metrics
Revenue Growth Rate
The percentage increase in a company’s sales over time. Strong, consistent revenue growth is crucial.
Earnings Per Share (EPS) Growth
The rate at which a company’s profits are growing per share.
Price-to-Earnings-to-Growth (PEG) Ratio
A more nuanced metric that considers both valuation and growth.
Formula: PEG Ratio = P/E Ratio ÷ Earnings Growth Rate
Interpretation: PEG around 1 may be fairly valued, below 1 may be undervalued
Return on Equity (ROE)
Measures how efficiently a company uses shareholders’ money to generate profits.
Growth vs. Value: A Direct Comparison
| Aspect | Growth Investing | Value Investing |
|---|---|---|
| Focus | Future potential | Current valuation |
| P/E Ratios | Typically high | Typically low |
| Dividends | Rare or none | Common |
| Risk Level | Higher | Lower to moderate |
| Time Horizon | Can be shorter | Typically longer |
| Market Conditions | Performs well in bull markets | Can outperform in bear markets |
| Company Stage | Often younger, expanding | Often mature, established |
Types of Growth Stocks
1. Rapid Growth
Young companies growing extremely fast (often tech companies)
2. Consistent Growth
Established companies that still grow faster than the market
3. Cyclical Growth
Companies whose growth follows economic cycles
Risks of Growth Investing
1. Valuation Risk
Paying too much for growth that doesn’t materialize
2. Execution Risk
Companies fail to execute their growth plans
3. Competitive Risk
New competitors emerge or technology changes
4. Market Sentiment Risk
Growth stocks can fall sharply when investors become risk-averse
Successful Growth Investors
Peter Lynch
Famed manager of Fidelity’s Magellan Fund, known for investing in what he called “ten-baggers” – stocks that grow ten times in value.
Lynch’s Advice:
- “Invest in what you know”
- Do your homework and understand the business
- The best stock to buy may be one you already own
Practical Exercise
Identify three characteristics that make a company a potential growth stock. Then, find one company that fits these criteria and explain why it qualifies as a growth stock.