Growth Investing

by Ian Harvey
September 03, 2019

Share

Growth investing, when there is a rallying stock market and a strong economy, which are typically led by the so-called "growth" investments, is a great time for options traders. These are the industries and companies that can -- and do -- grow profits faster than the economy. 

Defining Growth Investing and Growth Stocks…..

Growth investing is a style of investment strategy focused on capital appreciation. Those who follow this style, known as growth investors, invest in companies that exhibit signs of above-average growth, even if the share price appears expensive in terms of metrics such as price-to-earnings or price-to-book ratios. In typical usage, the term "growth investing" contrasts with the strategy known as value investing.

Because investors seek to maximize their capital gains, growth investing is also known as a capital growth or a capital appreciation strategy.

And, a growth stock is a stock of a company that generates substantial and sustainable positive cash flow and whose revenues and earnings are expected to increase at a faster rate than the average company within the same industry. A growth company typically has some sort of competitive advantage (a new product, a breakthrough patent, overseas expansion) that allows it to fend off competitors. Growth stocks usually pay smaller dividends, as the company typically reinvests retained earnings in capital projects.

Why Growth Investing?

Growth investors typically look for investments in rapidly expanding industries (or even entire markets) where new technologies and services are being developed, and look for profits through capital appreciation—that is, the gains they'll achieve when they sell their stock, as opposed to dividends they receive while they own it. In fact, most growth-stock companies reinvest their earnings back into the business, rather than pay a dividend to shareholders. They tend to be small, young companies (or companies that have just started trading publicly) with excellent potential.

Growth stocks are mainly associated these days with tech companies -- particularly in subsectors like the cloud where big things are happening and where money is flowing at a fast clip. Companies in these areas can be reasonably expected to post annual profit growth rates well in excess of 20% in the foreseeable future.

Selecting Companies for Growth Investing…..

Growth investors look at several key factors when selecting companies that may provide capital appreciation. These include…..

  • Strong historical earnings growth - Companies should show a track record of strong earnings growth over the previous five to 10 years. The basic idea is that if the company has displayed good growth in the recent past, it’s likely to continue doing so moving forward.
  • Strong forward earnings growth - It’s these estimates that growth investors pay close attention to as they try to determine which companies are likely to grow at above-average rates compared to the industry.
  • Strong profit margins - A company’s pretax profit margin is calculated by deducting all expenses from sales (except taxes) and dividing by sales. It’s an important metric to consider because a company can have fantastic growth in sales with poor gains in earnings—which could indicate management is not controlling costs and revenues.
  • Strong return on equity - This measures a company’s profitability by revealing how much profit a company generates with the money shareholders have invested. Stable or increasing ROE indicates that management is doing a good job generating returns from shareholders’ investments and operating the business efficiently.
  • Strong stock performance - In general, if a stock cannot realistically double in five years, it’s probably not a growth stock.

Other traits to recognize that are important for companies to undertake when growth investing…..

  • Taking advantage of expanding markets - successful growth companies go after large market opportunities. They accomplished by rolling out products or services in new business segments as they've grown. A company's ability to enter adjacent markets is often referred to as "optionality" and is a wonderful trait for growth investors.
  • Have a durable competitive advantage - simply put, this is a company's ability to maintain its competitive advantage over its rivals for a long period, thus keeping its profits protected from the forces of capitalism.
  • Financial resilience – means it is important for growth companies to fund their future growth needs with internally generated profits instead of being dependent on functional financial markets, particularly in times of market volatility.
  • Repeat business – it is best when a company makes money by selling products or services to existing customers instead of relying on an endless stream of new customers to drive growth.
  • Past price appreciation is strong - invest in growth stocks that have a history of producing market-beating returns - high-growth companies tend to keep on winning.
  • Good management - retaining its key employees for long periods of time and attract high-caliber new ones is beneficial.
  • Leadership of quality - is a CEO who is deeply committed to the company's mission and is highly incentivized to make the business a success. Often times these leaders are also the founders or co-founder of the business and remain heavily invested in the company's success.

Growth stocks trade on the stock market exchange and can be found in any industrial sector—but you’ll usually find them in the fastest-growing industries.

Using Growth Stocks for Options Trading

Here, at Stock Options Made Easy, we often use options trades surrounding growth stocks. Obviously the type of strategy we employ is based on whether the stock is performing well or is faltering.  

Since growth stocks hinge on valuing performance that is difficult to predict, they tend to be much more volatile than stocks that are backed by more established and predictable businesses. This means that investors seeking big growth should have a tolerance for high volatility. Just because a stock has lost a quarter of its value in a short period of time doesn't mean that it won't rebound to post substantial capital appreciation.

Our “Cut-to-the-Chase” member, as well as “Earnings Predictions” members, have enjoyed great success over the years by trading options on growth stocks.  


Best of Trading,
Ian Harvey
Director of Stock Options Made Easy


Share



”Success is simple. Do what's right, the right way, at the right time.”


Option Tip for your Success!
Options traders are not successful because they win.
Options traders win because they are successful.



Back to Stock Options Made Easy Home Page from Growth Investing