Growth investing involves selecting companies with fast-growing revenues and earnings. Typically, these are emerging companies in industries with substantial potential growth as well as innovative products or solutions.
But as such companies tend to trade at lofty valuations, there can be considerable risks involved with investing in them. To accurately evaluate a growth stock’s potential, one needs to examine and interpret subjective and objective factors including personal judgment.
1. Look for companies with high growth potential
Growth investors seek stocks with rapid market returns. They favor companies developing innovative new products or services likely to become popular and industries with high potential growth potential.
These businesses typically consist of small firms with high growth potential or startups in fast-emerging sectors such as technology or health care. Although they may not make much profit now, they anticipate increasing earnings and revenues that should result in increased stock prices over time.
Growth investing stands in stark contrast to value investing, which involves finding companies with modest sales and profit potential. Growth investing requires both a longer investment horizon and higher risk tolerance; as such it may not suit all investors. Furthermore, its volatility tends to make it less predictable.
2. Look for companies with high pretax profit margins
Pretax profit margins measure a company’s ability to turn sales into profits, by subtracting all expenses from gross revenue and dividing that figure by total sales volume. This measure provides more meaningful insight than net profit margins which simply measure what remains after taxes have been paid.
Examine companies with historically or projected high pretax profit margins as an indicator of potential growth stocks that could potentially increase earnings over time. This can help identify growth stocks with strong potential earnings growth potential.
Consider whether or not the sales growth rate exceeds that of its industry, which indicates that your potential investment is taking advantage of powerful long-term trends. Companies serving large markets tend to experience robust sales growth.
3. Look for companies with high dividend yields
Growth investing entails selecting stocks with anticipated faster-than-average growth potential in their industry, to achieve significant returns. While growth investing may lead to high returns, it’s essential that investors understand all associated risks before embarking on such an endeavor.
Investors seeking growth should look beyond dividend yield when selecting companies, however. Other criteria to keep an eye out for include long-term earnings growth expectations of 5- 15% as well as healthy cash flows to ensure dividend payments continue even if stock prices decline.
One potential drawback of investing in growth stocks can be that they do not pay dividends out to shareholders; rather, profits are reinvested back into the business to fuel future expansion.
4. Look for companies with low price-to-earnings ratios
Growth investors often serve as value investors by seeking companies which appear undervalued relative to their peers. This is particularly relevant when investing in cyclical industries that tend to experience significant drops in earnings year over year.
A P/E ratio can help investors identify stocks that match this investing strategy, but using the forward P/E ratio can narrow your search even further. This ratio incorporates expected annual earnings growth into its formula to enable you to quickly identify low-priced stocks with fast earnings growth potential.
Growth investing offers significant capital appreciation potential if you find companies with innovative products or services, or competitive advantages that stand out. But it must be remembered that growth investing requires an increased risk tolerance than other strategies.
5. Look for companies with high return on equity
Growth investing involves selecting stocks with the potential to outpace market performance, with the intention of realizing substantial returns by selling at higher prices later. This approach differs from value investing, which seeks undervalued stocks with hopes of increasing their intrinsic values.
Investment in growth stocks offers the possibility of outstripping market returns; however, they also come with greater risk. Thus, growth stock investing should only be undertaken by those with a high threshold for risk and sufficient investments capital to withstand any possible losses.
Companies with an excellent return on equity (ROE) tend to retain earnings and invest them back into business operations, leading to more sustained profit growth and sustainable profit expansion. ROE is one of the key metrics when considering investing in a company.
6. Look for companies with high return on invested capital
Investment in growth companies can generate market-beating returns, but comes with greater risk. Many growth investors choose mutual funds or exchange-traded funds (ETFs) that focus on specific sectors as a means to manage this exposure.
When searching for stocks to purchase, prioritize companies with high returns on invested capital (ROIC). This metric shows how much value a company creates per dollar spent on capital; those generating an ROIC above their cost of capital are adding value, while companies spending more than they earn are diminishing it.
Attaining the highest return on capital investment requires companies that raise revenues faster than their rivals; however, this may prove challenging in practice and it’s essential that investors search out companies with consistent growth over an extended period of time.
7. Look for companies with high return on assets
Companies with high return on assets are able to generate significant profits by investing their capital in growth opportunities, such as research and development, new products, acquisitions or other strategies that can boost sales and profits in the future.
Growth investors typically search for companies that can double their revenues within five years and boast high return on investment capital (ROIC), which measures how profitable these investments have become for shareholders.
However, this type of investment strategy can be risky. Growth stocks tend to be volatile and it can take years for these companies to turn a profit; furthermore, many growth-stock companies don’t pay dividends as their profits are reinvested back into fueling further expansion of the business.