Growth Investing

If you are looking for capital gains!

Growth investing is a strategy where an investor seeks out stocks that they they consider to have good growth potential.

A growth stock may be defined in most cases as a company whose earnings are expected to grow at a rate that is above average for its industry or the overall market.

Benjamin Graham provided an indication of what to look for in a growth stock. He looked for at least a 33% increase in earnings per share over a 10-year period.

He took the average of the first three years and compared it to the average of the last three years.

((Av. Last 3 yrs - Av. First 3 yrs)/Av. First 3 yrs )* 100.

He suggested that the greater the earnings per share growth was above 33%, the happier a growth investor would be.

Growth mutual funds, as the name implies, concentrate on stocks with the growth characteristics.


Growth and Value

Warren Buffett has been quoted as saying that ... "growth and value investing are joined at the hip" and that growth and value are what investing is all about.

In other words, it is somewhat nonsensical to try to distinguish between the two terms - but people do.

So it is not a matter of talking about growth versus value investing, but simply referring to investing.

A variant pioneered by Peter Lynch, now commonly referred to as a GARP (growth at a reasonable price) strategy is an approach to investing that (he says) combines growth and value investing.

It focuses on companies that have both growth potential and which can be obtained at a fair price.

When considering growth vs value investing, growth investors focus more on the future potential of a company, with less emphasis on its present price.

While value investors tend to focus more on current intrinsic worth, growth seekers are more concerned with future intrinsic worth and whether it is likely to exceed current valuations.


Growth Focus

Growth investors are looking for profits more from capital gains rather than dividends.

As a result they look for companies that are growing faster than others, and this means that the focus tends to be on young companies and rapidly expanding industries.

Companies that provide growth together with solid dividends are sometimes referred to as mattress stuffers for obvious reasons.


Identifying Growth Companies

The US National Association of Investors Corporation (NAIC) has developed some basic 'universal' guidelines for finding possible growth companies that include ...

• strong historical earnings growth for at least the last five years or more
• strong forward earnings growth of at least 10-12%
• evidence that management is controlling costs and revenues by maintaining or increasing profit margins and beating competitor profit margins
• signs that management operates the business efficiently through a stable or increasing return on equity (ROE) compared to the five-year average ROE of the company and the industry
• the likelihood that the stock price will double in five years - a good test of a growth stock since it implies a return on equity of close to 15%.

Growth companies keep re-investing into themselves to produce new products and technology.

A potential growth stock might be expensive when purchased, and above its intrinsic value based on historical figures.

But beware! Perceptions of growth can change rapidly in a downturn whereas value remains reasonably constant.

However, growth investors believe that if the company continues to re-invest most of its earnings by maintaining a low payout ratio, and can achieve an ongoing high return on equity (ROE), then this will ensure that the investment pays off in the long run.

To Conclude

'Growth' stocks share some of the characteristics that an astute investor adopting a value investing approach should be looking for.

Because of their particular characteristics, the opportunity to buy them below their intrinsic value occurs infrequently and makes them a higher-risk investment.

Nevertheless, I am comfortable with having a limited number in my portfolio if their growth story is compelling.

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