Methodology

Stocks

Module 4

Growth investing

Investors that follow a growth investment strategy, aim to increase their capital as much as possible and are not concerned about receiving income through dividends. They want to pick stocks that will grow significantly over time.  

 

Investors that follow a growth strategy, try to identify and invest in growth stocks, which are less developed companies that are expected to grow at a rate that is higher than other companies in their industry (or in the whole market).

 

They hope that the growth companies will expand a lot over several years, dramatically increasing the stock price. If that is the case, the investor will increase their own net worth significantly. An example of this would be Amazon, which has been recognised as a growth company across the last decade. It experienced significant growth, increasing its stock price from around $133 a share in January 2010, to around $3,650 a share in July 2021. So, if an investor had allocated $10,000 towards Amazon stock in January 2010, it would have been worth around $274,500 in July 2021. 

What are growth stocks?

In order to be able to invest in growth stocks, it is necessary to know what characteristics they have. Growth stocks tend to have a very high P/E ratio, not offer a dividend, operate with a unique product and have a loyal customer base.

 

A more recent example of a company that fits the definition of a growth stock would be Tesla. Tesla currently has a P/E ratio of 200 (as of April 2022), which is substantially higher than other car companies (i.e. Volkswagen with 5.34) and other technology companies (i.e. Apple with 27.76). With Tesla, it is a little more complicated, as they are both a car company and a technology company. Tesla also does not offer a dividend, has a unique product in their electric cars and has a fiercely passionate customer base that will defend the company as well as Elon Musk on platforms like Twitter.

 

Growth investors usually look at the financials of a company, rather than the stock chart. They observe how quickly the company has been able to grow its revenue so far, or try to calculate the financial potential of the products that the business is developing.

Growth investing & risk

Investing in growth stocks can be risky as they are young companies, with little to no track record in business. From the perspective of an investor, growth stocks are risky because they have high valuations (high P/E ratios). People are often very excited about the potential of a growth company, collectively pushing up their stock price to exceptionally high levels at times.

 

If a growth company fails to meet their targets, its stock price can fall sharply, as investors begin to doubt that the company will reach their expectations. In the worst-case scenario, growth stocks have the potential to go out of business, especially if they start to take bigger risks than they can handle or try to cut corners to meet targets. A good example here would be Theranos, which was an American growth company that drew the attention of investors in the 2010s. The business reached a peak valuation of $10 billion in 2013, only to go out of business in 2018. Theranos was closed down after it was found that the founder, Elizabeth Holmes, committed fraud by lying to investors about the development of their product. She claimed that they had developed a machine that would test blood for a range of diseases with just the small prick of a finger, only for it to be discovered that this machine didn’t exist at all.

 

So, as much as growth investing can lead to huge stock market gains over time, it also comes with significant risks when companies fail to meet expectations. If growth companies fail to meet expectations, it can result in significant losses for investors. With that said, growth investing is less risky than swing trading or day trading, as more time is given for the performance of the stock to be achieved.

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