Growth Investing

What is Growth Investing?

We’ve all heard of the FAANG stocks (Facebook, Amazon, Apple, Netflix, and Google) as examples of hyper-growth stocks, but opportunities in growth extend well beyond just technology.

Growth investing is a strategy that focuses on stocks that are growing their earnings and revenue at a higher rate than their respective sector and the overall market. This growth is expected to continue for the foreseeable future but there are no guarantees.

These companies are often at the forefront of emerging trends, are working to solve a significant issue, or have simply developed a better “mousetrap.” Take for instance Home Depot, which opened in 1978 and has grown into one of the largest companies in the world by offering customers a wide variety of merchandise at lower prices and with a highly trained staff. Or Netflix, which in 2007 launched a streaming service, thus ending the need for physical video/DVD rental companies.

History has shown us that the most successful growth stocks are younger companies boasting meaningful increases in quarterly/annual earnings per share, with new products/services that change our everyday lives. When it comes to identifying the best growth stocks, it’s best to focus on those companies with quarterly earnings per share growth of at least 20%, though this can be more difficult to find consistently in the large-cap space.

For investors, growth investing opportunities span across all industries. However, the most favorable have typically been Medical/Biotech, Consumer/Retail, Leisure/Entertainment, and Technology/Computer/Software. The true leaders can command triple-digit earnings multiples and offer quadruple-digit returns for those fortunate to uncover the winners early, with investing in the growth arena being a never-ending treasure hunt. This is why many investors choose to invest in growth stocks through exchange-traded funds (ETFs). ETFs make it easier for investors to have exposure to baskets of growth stocks based on particular industries and the market capitalization of the companies (small-cap, mid-cap, and large-cap).

Why Invest in Growth?

Growth stocks are attractive to investors because they offer the potential for outsized returns. For example, from 2010 – 2020, growth stocks rallied 372% compared to the S&P 500’s 297% gain. Over a larger time-frame from 1926 to 2017, Large-Cap Growth has returned 9.7% annualized, which is exceptional given that 1930-1950 was a lost decade for the market, as was 1972-1982, with minimal upside progress and violent secular bear markets.

Rather than looking for profits in the form of dividends from large, mature, less volatile companies, growth investors are searching for profits through capital appreciation. Capital appreciation is the rise in the asset’s (in the case a stock) price. Most growth stocks don’t pay dividends because they are still unprofitable or they reinvest their profits in order to develop newer and better technologies.

This is why growth stocks tend to outperform in bull markets. Investors have abundant confidence during bull markets and are willing to take on more risk investing in smaller emerging companies. However in bear markets, growth stocks tend to underperform as investors are more likely to be risk averse and often invest in more stable assets such as blue chip stocks, bonds, or gold.

Growth Investing vs. Value Investing

Value investing is an investment strategy based on fundamental analysis. While growth investors look for stocks with significant earnings and revenue growth, value investors instead search for stocks that have fallen out of favor and are undervalued in the marketplace. The expectation is that the prices of value stocks will appreciate when other investors recognize their true value.

Value investing is considered less risky than growth investing. That’s because value stocks are often larger, much more established, less volatile, and provide a source of income through dividends, regardless of capital appreciation.

Value stocks tend to outperform growth stocks during bear markets. For example, during the dot com bubble in the late 1990s, growth stocks significantly outperformed value stocks. However, when the recession hit in 2001, value stocks outperformed growth stocks.

Therefore, long-term investors often utilize both strategies, growth and value, to create a balanced portfolio. This allows them to realize returns throughout periods of economic expansion and contraction.

How to Invest in Growth

Though opportunities are abundant in the growth arena, only the most lucrative companies will survive, and competition is cutthroat. Given the difficulty in picking the winners, the best solution is investing through Growth-focused ETFs and mutual funds, which offer the following:

  • Diversification: protecting one’s self from a couple of disastrous ideas, and improving the odds of latching onto a massive winner.
  • Market-leading returns: with growth fund managers focused on capital appreciation and spending heavily on state-of-the-art research, and they can latch onto emerging trends and technologies early.
  • Fund management: skilled experts identify the best opportunities, and employ the best time-tested strategies to enter and exit positions. This takes the emotion out of the equation, which is what causes most individual investors to consistently underperform the market, even if they do uncover great companies

For those interested in Growth Investing, and potentially participating in the next major story like the massive FAANG outperformance in the past decade, a simple search on Magnifi displays numerous ways for investors to gain access to growth with low fees.

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The information and data are as of the August 12, 2021 (publish date) unless otherwise noted and subject to change. This blog is sponsored by Magnifi.

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