Growth Investing Explained (2023): What It Is, and How to Do It (2024)

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Have you ever taken care of a plant?

I mean an actual plant here—that requires water and sun. 🌱

Growth investing is very similar, in theory. You start with something small, like a seed, and aim to turn into a large, beautiful thing—like a plant.

Or bettter yet, greater wealth.

If this sounds like a good idea, you’re not alone. Growth investing is quite popular—it’s used by millions of investors. And to be perfectly candid, with the right tools, you don’t really have to be on a Wall Street executive’s level to be a successful growth investor.

With the COVID-19 pandemic persisting in 2021, growth stocks have been hotter than ever due to the disruptive market. The rising interest rates are testing the markets so if you are a wannabe investor, you need a solid strategy to generate the best returns. And growth investing may just be the strategy for you.

What is Growth Investing? 🌱

Considering diving into the world of growth investing? As with most other types of investing, you are going to need to have a pretty good idea of what exactly you are doing. Let’s break it down.

Growth investing is an investment tactic and style that focuses on increasing your capital. As a growth investor, you invest in growth stocks—which are stocks that provide a notably higher average rate of return than other stocks in the market.

Growth stocks are tied to businesses that possess solid characteristics that make them stand out above their rivals—these characteristics can include sales and/or earnings that outperform the market. Additionally, other factors such as brand value, competitive moat, and a loyal customer base can also be characteristics of growth stocks.

Since growth investing focuses on buying stocks linked to businesses that are set to “grow,” investors using this tactic can see some pretty impressive returns. This is especially true if the companies successfully grow in profits and revenue.

But, like with some other types of trading tactics, growth investing can pose a high risk if the companies attached to the stocks don’t perform as predicted.

Growth Investing is Not Value Investing

Most people know that value investing contrasts growth investing—but it’s very important to understand the differences. Value investing is a strategy that focuses on selecting stocks that appear to be less favorable in the eyes of Wall Street. These stocks look to be trading for less than their book, or intrinsic, value and are underperforming the market average.

Value investing is about striking gold—meaning the investor finds a company whose stock prices do not reflect their true worth. They don’t emphasize exponential growth and have more limited upside potential. This makes them more ideal for risk-averse investors. 🦺

Growth investing is a more aggressive approach with a “go big or go home” mentality as they offer significantly higher potential gains. Therefore, growth stocks are well suited for an investor with a higher tolerance for risk and a long-term horizon.

For some more experienced investors, growth investing is a tried and true tactic. And recently, even the most famous of value investors, like Howard Marks, are acknowledging the great potential from growth investing.

Growth Stocks vs. Value Stocks

How to Be a Growth Investor 📈

Successful growth investors see very attractive returns. However, growth investing can be very risky, especially in comparison to strategies that focus on value stocks.

There are six common characteristics that set growth stocks apart from other types of stocks:

1. High Growth Rate: Growth stocks usually show an established history of growing at much faster rate than other types of stocks.
2. No (or low) Dividends: These stocks do not pay dividends because the companies allocate more funds into business/revenue growth.
3. Loyal Consumer/Customer Base: Growth stocks are linked to established companies with high quality and/or innovative products/services, therefore returning loyal and repeat customers.
4. Competitive Advantage: Growth stocks excel in their market of choice because of a specific and unique “It Factor” the company possesses.
5. Revenue: Companies tied to growth stocks have consistently positive revenue and earnings postings.
6. Risk Factor: Growth stocks tend to be riskier because of their volatility.

Keeping the six characteristics in mind is the first place to start. But, to become a growth investor, there are some additional steps we recommend you follow.

Prepare Your Capital 💸

The first step to take on your journey of becoming a growth investor is to get your finances in gear. You do this in the form of preparing your capital and assessing your financial health.

Times are tough in the current COVID-19 world, with 40% of Americans taking emergency financial measures. Therefore, be careful to not go overboard with the money you set aside for investing. And remember that you can be in some serious trouble if you inject all of your spare cash in growth stocks. 😳

Many advisors recommend that you shouldn’t buy stocks with the cash you will need in the immediate future, or at the least in five years. This rule is based on the fact that the market may frequently have unexpected sharp drops of up to 20% or more.

Even though the market in general will rise over the long term, it’s a risk to put yourself in this position to need to liquidate your positions during one of those unexpected down periods.

Therefore, preparing your capital as a growth investor is a solid first step. You’ll be able to afford to make routine and frequent stock purchases and you’ll be able to keep your finances in check even if the market isn’t behaving.

Before buying any stocks it’s important to understand a few financial basics. These basics are especially important to grasp before investing in the more volatile growth stocks.

1. Focus on increasing your cash flow by cutting expenses and increasing your income streams.
2. Eliminate debt, especially focusing on high-interest debt.
3. Construct a solid emergency fund equal to 6 to 12 months of expenses.
4. Research a variety of brokers and then open a brokerage account.

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Think Long-Term ⏱️

Once you’ve prepped yourself financially, it’s time to prepare your strategy. To begin preparing you must first dedicate some time to researching the market. And as with most things in life, for you to see growth you must invest one key aspect—time. You must be willing to invest the time (and patience) to witness the exponential growth. Remember, the popular saying that time in the market is generally better than timing the market.

When you decide to become a growth investor, you should be in it for the long haul. Growth stocks pose a greater risk than some other types of stocks, therefore the longer your time horizon, the more flexibility you will have.

Focus on well-established businesses with a long history of positive earnings and profits. Additionally, you can focus on investing in companies with the best-performing businesses and market share gain, taking less of a focus on share price.

Whatever strategy you may pick, It’s important you pick one and stick with it. Avoid “chasing the market” by switching trade tactics just because it seems better in that specific moment.

Becoming a market chaser is a surefire way to see an underperforming portfolio in the long run. By picking your tactic and remaining consistent with your selection, your portfolio is likely to perform the best it possibly can.

Explore Your Investment Options 🗺️

The next step is to begin weighing your options, specifically your investment selections. How much cash do you want to use for your growth investment strategy? What is your risk level? What stocks are good to buy for the strategy?

And finally, after assessing the stock’s risk, do your research on the overall best growth stocks to buy. After all, growth investing is more effective with the correct securities.

Evaluate a Company’s Growth Potential 🧠

Historical Earnings Growth📜

Look for companies with a strong track record of solid earnings growth over the last five to 10 years. What you are looking for in the minimum earnings per share growth really depends on which company you are looking at, and its size.

However, the key thing is that if the company has shown consistent, good growth in the recent past, the odds of it continuing this growth in the future is high.

Forward Earnings Growth 📅

Most companies release a public earnings announcement revealing their profitability for a set time. Usually, on an annual or quarterly basis, these scheduled announcements follow earning estimates by equity analysts. Pay close attention to these estimates when determining which companies will grow at an exponential rate in comparison to others in its industry.

Solid Profit Margins 💸

Pretax profit margins are calculated by deducting company expenses from their sales and then dividing that number by total sales. You need to take a close look at a company’s profit margins because a company can have substantial growth in sales, but poor gains in earnings.

This potentially indicates poor cost and revenue management. If a company is beating its previous five-year average of profit margins, then keep your eyes on them for your investment portfolio.

Good Return on Equity (ROE) ✅

Return on equity (ROE) is a metric that measures a company’s profitability by disclosing their generated profits from shareholder’s invested money. To figure up a company’s ROE, you divide net income by shareholder equity.

Stable or consistently rising ROE typically means that the company’s management is successfully generating returns from the shareholders’ investments while also operating the business efficiently.

Stock Performance 📈

Keep your eye on the history of the stock. More than likely, if the stock has not doubled or at the least increased significantly in the past five years, it’s not a growth stock. To double in five years a stock must only have a growth rate of 15%, which is pretty achievable for up-and-coming companies in booming industries.

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Maximize Your Returns ⬆️

Even though the goal of a growth investment strategy is to hold onto your investments for several years, you will still want to keep a good eye on price changes. Watching your returns and the rate at which they grow is important for seeing the max growth possible. And since growth stocks tend to be volatile, this is even more important. Here are a few important reasons to keep an eye out:

• Get used to the possibility of having to rebalance your portfolio. You may find yourself needing to do this if a specific stock in your portfolio has rapidly gained in value.

• If a stock exceeds your expectations for growth, consider ditching it. This is especially beneficial if you have found another stock that has a better price.

• You may want to consider selling if the company has hit an unexpected rough patch. Especially if this puts a wrench in your original projections or if it veers off the path that led you to buy in the first place. If the company faces mismanagement, sees a long-term decrease in pricing, or a lower-priced competitor interferes, it may be time to jump ship.

Types of Growth Investments 💲

There are three main types of growth investments: Small-Cap Stocks, Technology and Healthcare Stocks, and Speculative Investments. All three categories have shown the greatest growth potential, as they all involve equity and a higher level of risk.

Small-Cap Stocks 🤏

Companies that are considered “small-cap” are generally classified by analysts as having capitalization between $300 million and $2 billion. However, there is no set or specific definition of what exactly is a small-cap stock.

Tech/Healthcare Stocks 📱

Let’s face it, the advancement of technology and healthcare innovations have both majorly impacted the world through the years. Therefore, the next category of growth stocks includes technology and healthcare. These two major industries are constantly innovating and improving their products, always offering their investors exponential growth in a somewhat short period of time.

An illustrative example is the longtime pharmaceutical brand and COVID-19 vaccine manufacturer, Pfizer (PFE). The pharmaceutical company’s share price was just around $5 in 1994 before they released Viagra. Just three years later in 1996 More recently, Pfizer rose 5 times to almost $25 a share.

Another fresher example is video communications company Zoom (ZM), which had a share price of around $105 in February 2020. Just eight months later Zoom shot up to $559 a share after the company’s popularity spiked in the wake of the COVID-19 pandemic.

Moreover, with the introduction of 5G technology, it has the potential to go up even higher. Like many growing tech stocks that have remained healthy during the pandemic, Zoom is expected by the experts to post a significant increase in earnings reflecting a year-to-year change of over +420%.

Speculative Investments 🔎

The last category, the speculative investments, is for all the speculators out there who like to take a little more risk. These investments are high-risk growth instruments inclusive of options contracts, penny stocks, foreign currency, and real estate like undeveloped land.

With speculative investments, investors have the potential to see a major return on capital. But, also be very careful when messing with speculative investments as you can also lose every bit of your initial investment. For instance, some of the GME speculators made a fortune, while others who arrived too late, got huge losses because of the stock’s volatility.

What is Dividend Growth Investing ❓

Another related investing tactic worth taking note of is dividend investing. This investment strategy consists of buying shares of companies that pay consistent quality dividends. Dividends, for reference, are direct cash payments from the company paid out in an effort to return some profit to the stockholders.

Dividend growth investing involves letting the shares sit and grow—that is unless you decide to buy more, of course. What companies are good contenders for dividend investment?

A company that pays dividends, experiences consistent growth over the years, covers its expenses, and has a continuous cash flow are all good dividend growth investment contenders.

Lastly, these companies typically slowly increase the total dividend payments that are paid to their shareholders as a result of growth.

Dividend growth investing is a good option for investors with a shorter time horizon and who are looking for more liquidity. In contrast, growth investing is more ideal for an investor with a longer time horizon who desires less liquidity. Growth companies spend money on growth while dividend-paying companies focus more on controlling expenditures.

Growth Investing vs. Dividend Growth Investing

Famous Growth Investors 🌟

Need some inspiration? Perhaps some motivation? Well, take solace in knowing that growth investing tactics have worked for many investors over the years. And just a few of the many growth gurus to admire are Thomas Rowe Price, Jr., Philip FIsher and Peter Lynch.

One of the most famous growth investors is Thomas Rowe Price, Jr. Dubbed the “father of growth investing,” Price established the T. Rowe Price Growth Stock Fund in 1950—this mutual fund averaged a whopping 15% annual growth for 22 straight years. The fund is also the first mutual fund offered by T. Rowe Price associates, his namesake advisory firm, and is still one of the largest financial services firms worldwide today.

“Change is the investor’s only certainty.”

– Thomas Rowe Price, Jr.

Another famous growth investor is Philip Fisher. Fisher emphasized just how important research is when it comes to growth investing in his 1958 book Common Stocks and Uncommon Profits. Today, his book continues to be a very popular growth investing resource for investors everywhere.

Lastly, the manager of Fidelity Investments’ famous Magellan Fund, Peter Lynch, is another growth investor to take notes from. Lynch created a hybrid model of growth and value investing which is now widely referred to as the Growth At A Reasonable Price (GARP) strategy.

Growth Investment Examples 📋

We briefly explored some examples of growth stocks—but now let’s dive a little bit deeper with some more examples. A growth stock’s biggest characteristic is linked to the company: specifically the company’s performance, marketability as well as customer base.

If you had invested $500 in 1997 when the share price was $1.73, today in 2021 you would have almost $900,000. The 193,000+% growth in 24 years is an impressive example of just how well a growth stock can perform.

Another example is content streaming and production service Netflix (NFX). Originally a DVD mail rental service, the company was founded in 1997 and became publicly traded in 2002.

The share price was roughly $1.21 in 2002, compared to today’s $530+ (February 2021.) This means that if you had purchased $500, or roughly 413 shares, of Netflix in 2002, you would have almost $219,000 today.

One more illustrative example is the newer digital media company Roku (ROKU), which became publicly traded in 2017 with a share price of a little over $26. Today, ROKU has a share price of almost $400 just four years later, reflecting a 1660% growth.

Warning for Growth Investors ⚠️

Growth investing, while a profitable and solid investment tactic, also has its downsides. Perhaps this biggest downside is the risk that can be involved with growth investing.

Therefore you must assess if growth investing is right for your risk levels and time horizon. In general, the more time you have, the greater your tolerance for risk. This is mainly because you have time to recoup your losses.

Next, remember to be mindful of taxes and brokerage commission fees charged by stock brokers. You are subject to gains taxes on any short-term investments (generally assets held less than two years.)

So, buying, holding, and selling in the short-term may increase your tax bill. Most brokerages also charge commission fees so keep that in mind as well when investing.

If you’re a long-term investor, consider opening an Individual Retirement Account at a leading brokerage. Because of the tax advantages associated with IRAs, they are one of the best ways to safeguard your money from Uncle Sam. Not to mention you can maximize your returns over the long run by investing in target retirement growth funds.

The Bottom Line

Growth investing is a solid investment tactic that can yield some impressive results for many investors. But before taking the leap to become a growth investor, weigh other investing tactics such as value investing and dividend investing to see which is right for you.

If you’ve come full circle to the decision that growth investing fits your investor profile, then make sure to take the careful and proper steps to become a growth investor.

These steps include preparing your capital, exploring your options, and evaluating a company’s growth potential. And remember to think long term as the volatility of growth stocks are likely to work in your favor in the long run.

Listen to the experts, who currently advise to approach growth stocks cautiously and do your homework. If you’ve got the gall to research, analyze and study up, you too can perhaps be on T. Rowe Price’s level of legendary growth investor.

Get Started with Growth Investing

All reviews, research, news and assessments of any kind on The Tokenist are compiled using a strict editorial review process by our editorial team. Neither our writers nor our editors receive direct compensation of any kind to publish information on tokenist.com. Our company, Tokenist Media LLC, is community supported and may receive a small commission when you purchase products or services through links on our website. Click here for a full list of our partners and an in-depth explanation on how we get paid.