Growth Investing is an investment strategy and Philosophy that aims to identify companies with the potential to grow at an above-average rate. The primary objective of a Growth Investor is to increase their capital over the long term. To achieve this, growth investors typically look for companies in fast-growing industries that are often small-cap and poised to expand and increase profitability in the future. While growth investing has the potential for higher returns, it also involves a higher level of risk and volatility, which can be mitigated by following a disciplined investment process.

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What is a Growth Investor?

A Growth Investor is someone who focuses on the future potential of a business. They are less concerned with the price paid, like a Value Investor, and more concerned with the growth, scalability, and future size of the company. When evaluating companies, they often ask themselves, “How big could this business be?” with the goal of compounding their capital at higher rates, usually with a long-term horizon.

A true Growth Investor focuses on identifying future market leaders, buying them early, and riding them to maturity. This is how early investors in mega-cap companies have seen life-changing returns from multibagger stocks.

Growth investing requires sifting through the hype, story stocks, and noise around “the next big thing” and looking in-depth at the business. It involves searching for answers around the company’s technology or innovative offering, the size of the total addressable market (TAM), operating leverage, future optionality, competitive advantage, and how this company could “cross the chasm”.

As a growth investor, you need to think logically and invert the ideas around current growth opportunities. While other investors may pile in because of euphoria, you need to take a step back and consider the reality of the company’s future.

How does Growth investing work?

Growth investing focuses on finding the best companies that have the potential to outperform the market in the long run. Such companies are chosen based on different factors, including strong growth in earnings per share, sales growth, profitability, and diligent allocation of capital. It’s worth noting that many growth stocks may not be profitable as they usually reinvest their earnings and cash flow back into the business to help it expand.

Investors who look for growth opportunities usually focus on businesses that are already demonstrating better-than-average growth, which often leads to the companies trading at high multiples like Price-to-Earnings, Price-to-Sales, and hovers around their 52-week highs. This is because growth attracts investors.

As shown in the above image, sales growth drives long-term share appreciation over 5+ years. Therefore, growth investing looks beyond the current share price and evaluates how much room the company has to grow. Without a significant revenue pipeline and a large customer base, it’s difficult for a company to scale.

A lot of Total Shareholder Returns (TSR) come from long-term revenue and profit growth. Finding quality growth companies that can deliver year-on-year growth for years requires identifying industries and markets that have the potential for growth. Ideally, such companies should be at the beginning of their journey, with a large market ahead, the right capital allocator, and the right product and offering that has an underlying business model poised to create margin.

Companies with significant future expansion potential can deliver mouthwatering returns to those who patiently hold as the business goes through different cycles.

How do Stocks enter a Growth stage?

Stocks usually enter a growth stage when they offer products and services in rapidly expanding industries. These industries could be areas where there is disruption happening, whether due to new technologies, products, or services in high demand. Growth investors are typically interested in companies that can benefit from the growth of sectors that are expected to grow much faster than others. These sectors include technological advancement, healthcare, and catering to growing and evolving consumer appetites.

Companies are usually able to take advantage of economies of scale, with strong competitive advantages such as network effects, strong brands, and switching costs. They are often found in industries that are following a market trend such as AI, electrical vehicles, SaaS, cloud computing, streaming, cybersecurity, and industries with rapid global expansion.

While this is not always the case, these types of companies are the most sought after. However, growth companies can fall into several industries, as it all comes down to the business, its offering, the business model, and how big the market is that it is going after. For example, think of fast food chains expanding across the US or Southeast Asia, industrial companies servicing emerging markets, and online retail and consumer staples. Many growth companies fall outside the typical high-tech scenarios.

The most common place to find growth companies is in younger small-cap companies that are believed to outperform the industry in the coming years. These companies will experience rapid sales growth, which then starts to generate positive earnings. Once these companies pass the break-even point, they start to reinvest a lot more free cash flow back into the business.

What are the Pros and Cons of being a Growth Investor?

There are a few considerations before looking to implement this successful investing style into your philosophy and strategy. I have listed a few pros and cons to think about. Reflect on each one to help form your own belief and opinion about growth investing.

➕ PROS	➖ CONS
Growth stocks provide a high rate of return as a long-term investment option.	Growth stocks can be high-risk and may not be ideal for investors with a low-risk appetite.
Usually, potential market leaders post constant returns that lead to increased TSR.	Due to potential returns they usually trade at high valuations which makes some investors nervous. They can always be trading at 52 week highs.
Compounding makes potential returns more compelling if buy them early and hold them.	Typically pays no Income dividends which may not suit those investors needing income.
Usually have great competitive advantage the more the company delivers to customers.	Need to be patient while the company grows and there may be no return for long periods of time.
Can accommodate concentration by buying and holding great quality growth companies.	Expensive stocks can be overvalued as the hype pushes the price up with no outcome.
Growth stocks do not require a huge capital outlay which is ideal for those looking to grow their wealth early.	Challenging to sift the real growth stories from the hype, story stocks, and “hot” trends.
Growth shares tend to outperform during bull markets when investor confidence is high.	Usually found in Small-Cap space which makes research, analysis and data harder to interpret.
Can be innovative companies in emerging industries, solving problems and disrupting stagnant markets.	Difficult to identify great growth companies in advance. Requires a lot of research, understanding of the industry, trends, total addressable markets.
Potential future dividend payers, leading to high dividend yields.	Growth shares tend to underperform when the market provides unfavourable conditions.

What are the Characteristics of a Growth stock?

When searching for growth companies, it is crucial to understand what sets them apart and makes them fit into the “Growth” category. It’s important to distinguish real growth ideas from the many story stocks that have been hyped up in failed industries that were supposed to be the next big thing but never delivered. Many bubbles have come and gone, from the dot-com era to cannabis. Although money was made as the bubble grew, the short-term growth is difficult to replicate based on sound fundamentals.

Companies can enter growth stages by being pioneers in their field with innovative disruption. Companies that are entering a growth cycle can be pre-profit, coming out of the launch phase.

The small-cap and micro-cap segment can be a great place to start, but that does not mean mid-caps or already large-cap stocks cannot still rapidly expand. Growth companies may not have a lot of history of success, but they show the potential to exceed their peers in their industry.

Growth companies will usually have these characteristics and metrics:

• Rapid Growth, niche sector, playing to an emerging trend.
• Focuses on top-line growth OVER profitability. Leads to long-term growth.
• Always overvalued by P/E, P/S and enterprise value standards.
• They are in sectors that have an expanding Market not a shrinking one.
• Strong competitive advantage which needs to be deeply understood.
• Historical Growth and Increase YOY: Sales / EBITDA / EPS / CASH FLOW.
• Higher volatility, and fluctuations, all effected by Mr Market.
• No dividend payout as reinvests back into the business.
• Fanatical CEO or a dedicated founder with great capital allocation skills.
• Reinvests into R&D and Marketing to continue innovation.
• Disruptive business models with untapped operating leverage.
• High Returns on Equity and Capital.
• Strong forward earnings growth and analysis calls.

How to consider the Growth investor approach in your Philosophy?

Growth stocks are usually expensive when analysed by standard multiples, making them poor investments to determine value. To become a successful growth investor, it’s important to understand that many of these stocks never live up to the hype and can result in capital loss. This investment philosophy usually requires taking risks and accepting losses on failed investments, with the expectation of outsized returns from a few successful ones.

Investing in growth or hyper-growth companies requires a higher appetite for risk and a longer time horizon, as well as patient capital. While it can be exciting to invest in these companies, many sell out due to the volatility and fluctuations that come with growth. However, to benefit from growth investing, you need to hold on to your investments with conviction and a strong stomach.

While growth investing is typically suited for an offensive and aggressive investing style, anyone can benefit from an allocation towards growth, even in a defensive portfolio mix. It’s aimed at those looking to grow their capital and increase their net worth at a faster pace.

To implement a growth investing strategy, investors need to understand fundamental analysis and how to value these companies in different ways. Using a DCF or multiples analysis may not be suitable, as it’s hard to forecast a business as it enters hyper-growth, and predictions are often wrong. This means investors must think differently to determine possible outcomes.

Most growth investors focus on qualitative analysis, understanding the industry, market potential, and how a business can solve a problem, rather than running hypothetical DCF models. The investment process for Growth is usually a top-down, thematic theme or industry-focused approach. Rather than a bottoms-up Value Investor style, growth investors focus on trends, and industries poised to grow and then start their filtering in that way.

What do I think about Growth investing?

As a Growth at a Reasonable Price (GARP) investor, my focus is on companies with growth potential. Being young and having a reasonable appetite for risk, thanks to my experience with many failed start-ups, I am looking to compound my capital at above-average rates. I am inclined towards growth because I like the idea of companies doing the heavy lifting to provide me with returns. Once I conduct thorough due diligence and take a position, I monitor and observe the investment thesis to ensure it remains in check. Beyond that, I do very little.

I believe growth investing doesn’t have to be high-risk. Picking companies with the best qualities after conducting quantitative or qualitative analysis and holding them long-term is a great wealth-building strategy. Derisking the hype and noise, especially in new sectors or emerging trends, is key. I don’t mind giving up some initial gains if it means being late to a trend while I sit and observe it playing out. I may miss out on some gains on the initial upswing, but letting the dust settle from the hype can minimize a lot of downside risk.

If it is a growth company with a long runway ahead and is in its early stages, I don’t mind missing a few percentage points while I watch the company deliver. I tend not to value these companies too much because it is very hard to extrapolate sales and forecast hyper-growth companies. If a business is about to enter an inflection point, we are likely to seriously underestimate its intrinsic value.

In Summary…

Investing in Growth companies has its benefits. These companies are usually innovative and disruptive, fulfilling a need in society, and going against the grain of outdated industries or business models. As an entrepreneur, I love backing such companies that are making a difference.

While some Growth companies may seem expensive, I believe that value is subjective and depends on factors such as the potential, the product or service, the market size, and the market growth. In my opinion, some companies may be undervalued compared to their opportunity and return potential.

Investors often miss out on growth opportunities by waiting for an undervalued buying opportunity that may never come. Although some of these company’s trade near all-time highs, there may still be a lot of growth left to make sizable gains.

Growth investors typically focus on trending emerging sectors, such as AI and EVs. However, I have found that some of the best gains came from Growth companies that were not in tech.

For instance, a fast-food chain expanding across a country, a furniture outlet expanding online and warehousing across Southeast Asia, a paint supplier penetrating an emerging country, an engineering service provider to the mining and maritime sector, and a hospital franchise expanding across the country.

These industries were not in tech, but they all had great management, strong margin business, competitive edge, and rapidly growing sales in a big and expanding market. Most importantly, diligent capital allocation with high returns on capital that was able to carry on for years.

In conclusion, Growth is Growth!