Growth investing is an investment strategy that focuses on buying stocks of companies expected to grow their earnings or revenue at an above-average rate compared to the broader market.
Understanding growth investing
Growth investors look for companies with strong potential for future earnings expansion. These companies generally reinvest their profits back into the business to fund acquisitions or develop new products, rather than paying out dividends to shareholders. The primary goal of this strategy is capital appreciation. Investors profit when the stock price rises over time as the company increases its market share and revenues.
Because of the high expectations for future performance, growth stocks usually trade at high price-to-earnings ratios or price-to-book ratios. Investors are willing to pay a premium now based on the anticipation of significant returns later. If a company fails to meet these high growth expectations, the stock price can experience sharp declines. This makes growth investing highly susceptible to market volatility.
While value investing focuses on finding undervalued stocks, growth investing focuses on the trajectory of the company regardless of the current stock price. This approach carries specific financial risks. It requires Elephants to carefully analyze a company’s business model and target market size to determine if the projected growth is realistic over a multi-year horizon.
Example
Imagine a publicly traded company called “TrunkTech” that produces advanced tracking monitors for elephant herds across wildlife reserves in Africa and Asia. TrunkTech currently reports low net income because it spends all its available capital on research and development to improve its satellite tracking technology. An investor expects TrunkTech’s sales to double over the next three years as national parks globally adopt the new system. By purchasing shares of TrunkTech now at a high valuation multiple, the investor is engaging in growth investing. The investor assumes the rapid expansion of TrunkTech’s operations will drive the stock price higher in the future, compensating for the lack of current dividends and the high initial purchase price.