Growth Investing in a Sophisticated Market
Most investors will agree with the assumption that the concept of growth investing is alien to day traders.
When you observe closely, however, every day trader will always assess their portfolio at the end of the trading session to see how many pips they added to their account. If the number of pips increases consistently over time, then that makes the trader good. However, this increment is nothing more than growth put in a different language.
At the end of the year, the same trader will sit down and see how much the portfolio grew over the past 12 months. Yet if you were to ask him the type of investor he was, he is most likely to call himself a day trader. Therefore, in every aspect of investing, the most crucial element is growth.
The same concept is employed when evaluating the performance of a stock, mutual funds, hedge funds, equity funds and even regular businesses over time. The rate of growth and the average rate of return on an annual basis always comes into play.
Did you know most lenders assess a business’ growth prospects and cash flow expectations before deciding whether to give them a loan?
This helps them determine the company’s ability to generate more money in the future. If there is money in the pipeline, then there will be no issues in servicing the loan.
Who exactly is a growth investor?
In short, most people who call themselves growth investors do so because they give the money to someone with the hope of growing it over time through shrewd management. Take, for instance, investing in a growth stock. You do so because you believe there is a huge opportunity for the company to grow in a few years’ time, which means you are entrusting your investment to the management of the company.
In most cases, this type of growth is associated with dividend stocks, in which case analysts calculate it using the dividend growth prospects. However, some dividend kings like Johnson & Johnson (NYSE:JNJ), which has a divided yield of about 2.37%, and General Electric (NYSE:GE), which has 3.56% yield, do not necessarily qualify as growth stocks.
These are rather good candidates for retirement stocks as they are capable of paying dividends indefinitely.
The most realistic candidates for growth investing, even without any dividends, are found in small-cap stocks, also sometimes categorized as penny stocks in various platforms. For those who prefer the less risky blue-chip growth stocks, there are a few that stand out.
In this case, most operate in the technology sector and some trade at several times the price-earnings (P/E) multiple. Good examples in this case are Amazon.com Inc. (NASDAQ:AMZN), which has a P/E ratio of 192.2 times, and Netflix Inc. (NASDAQ:NFLX), with a P/E of 224.8 times. Neither company pays a dividend.
The stock prices of both Amazon and Netflix have rallied significantly over the last three years, each gaining more than 180%. On the other hand, Johnson & Johnson gained 35% while General Electric remained flat with a gain of just 3%, as illustrated in the first chart.
Essentially, growth investors tend to bet on the potential rather than the current value of a stock and believe the company’s current management team will help to deliver this potential in the long run.
On the other hand, derivatives or currencies traders entrust themselves with managing the money well, when they make the first deposit into their derivatives brokerage account. In this case, the equity accounts are the growth asset and annual returns are based on how well they perform during the year. To them, it does not matter much what the future holds for the underlying assets. All they are interested in when trading is the short-term volatility. Meanwhile, for those investing in a growth stock, the company is the asset and the annual returns are based on how well it does during the year in both revenues and profits.
So both investors in this case are focusing on growth at the end of the year, with the only difference being the person tasked with achieving that growth. It sounds utopian, but those are the facts.
Identifying growth stocks
Growth investors describe growth investing as a strategy that tries to identify stocks that have promising growth metrics when compared to their peers and the industry averages, in terms of revenue and profits. Some of the most famous growth investors include Thomas Rowe Price and Phil Fisher, while legendary investors such as Warren Buffett (Trades, Portfolio) believes there is not much difference between growth investing and value investing.
Nonetheless, when it comes to picking growth stocks, growth investors look at various market indicators. Some of the most common ones include industry growth projections as well as market trends in the specific business segments a company operates in. As such, most growth stocks are closely tethered to the emerging markets and other promising marketplaces in tech, biotech, fintech, artificial intelligence, augmented reality and virtual reality.
These companies also tend to be small in nature, although it is possible to find growth in some blue-chip stocks as well. In addition, growth investors search for opportunities in special situation companies that are undergoing restructuring, spinoffs, mergers and acquisitions or have new product discoveries.
Conclusion
Growth investing is more about the potential of a given stock or asset to generate more income in the most immediate future rather than the present performance.
While this type of investing is associated with the stock market, sophisticated investors, such as those involved in the derivatives market, must also assess the level of growth in their portfolios at the end of the year.
It is the same principle applied by investors looking to invest in mutual funds and hedge funds. Therefore, as the financial markets continue to become more sophisticated, the concept of growth will always play a part.
Disclosure: I have no position in any stock mentioned in this article.
