Are you someone who has always wanted to dip their toes into stock market investing but found the whole thing a bit daunting? Well, fear not because we’ve got you covered.
The truth is, investing doesn’t have to be complicated. With a little bit of know-how and a lot of patience, anyone can build a solid investment portfolio that suits their needs.
In this article, we’ll take a closer look at one of the most popular investing strategies out there: Growth Investing. We’ll break down the steps involved in this approach so that even if you’re a complete novice, you can get started with confidence.
So sit tight and get ready to learn how to make your money work for you!
Table of Contents
What is Growth Investing?
Growth investing is a popular investment strategy that focuses on investing in young and small companies that are expected to increase their earnings at a faster rate than other companies in their industry, making it a great option for anyone looking to grow their money through investments.
Investors who use growth investing are usually attracted to the potentially high returns that can come from investing in new and emerging companies. However, it’s important to remember that these companies can be risky since they haven’t been tried and tested yet.
In contrast to growth investing, there’s also value investing. This investment strategy involves looking for stocks that are undervalued and trading for less than their intrinsic or book value.
So, which one should you choose? It really depends on your investment goals and risk tolerance. If you’re willing to take on more risk in exchange for potentially higher returns, growth investing might be the way to go. But if you’re looking for a safer, more conservative approach, value investing might be a better fit for you.
Step 1: Prepare your finances
Before you jump in, it’s a good idea to assess your financial situation and decide how much you can afford to invest. A good rule of thumb is to avoid investing cash that you may need in the next five years, as the stock market can be unpredictable and volatile.
The market tends to rise over the long term, but it can also experience sudden drops of 10%, 20%, or more. These dips can happen unexpectedly, and one of the worst mistakes you can make as an investor is being forced to sell your stocks during a down period. That’s why it’s important to invest wisely and not put yourself in a precarious financial position.
As a growth investor, you want to be in a position to buy stocks when others are selling. This means being prepared for any market situation and having the financial flexibility to take advantage of opportunities as they arise. With a smart investment strategy and a long-term mindset, you can position yourself for success in the stock market.
Step 2: Choose a growth investing strategy
Now that you’ve taken steps towards financial stability, it’s time to enhance your investment toolbox with knowledge. Growth investing offers several strategies that you can choose from depending on your investment goals. Here are some key things to keep in mind when selecting a growth investing strategy.
Consider the Company’s Track Record
One approach to growth investing is to focus on well-established businesses that have a history of generating positive earnings. This method typically relies on quantitative metrics like operating margin, return on invested capital, and compound annual growth rates. This approach is ideal if you prefer to make informed decisions based on a company’s financial history.
Purchase High-Performing Businesses
Some growth investors prefer to purchase the best-performing businesses, evidenced by their consistent market share gains, with less focus on share prices. This approach is better suited for investors who want to make informed decisions based on a company’s future growth prospects.
Invest in What You Know
It is generally advisable to invest in industries and companies you are knowledgeable about. Having experience in a specific industry or working for a specific type of business can help you evaluate potential buy candidates. It’s better to know a lot about a small segment of companies than it is to understand just a bit about a wide range of businesses.
Consistency is Key
Once you have chosen a growth investing strategy, it’s important to stick with it. Avoid the temptation to switch strategies just because it appears to be working better at the moment. Chasing returns is a sure way to underperform the market over the long term.
Learn from the Masters
Read a few classic growth investing books to familiarize yourself with the tenets of this stock market investing strategy.
T. Rowe Price, the father of growth investing, helped popularize the idea that a company’s earnings growth could be projected out over many years, shifting investors’ thinking at a time when stocks were considered cyclical, short-term investments. Warren Buffet, although known as a value investor, also incorporated elements of the growth approach.
His quote, “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price,” sums up the idea that the strength of a business is just as important as its price when making an investment decision.
Step 3: Stock selection
To begin with, you’ll need to decide how much of your portfolio you want to allocate toward growth stocks. If you’re new to this approach, it’s generally a good idea to start small, perhaps with around 10% of your portfolio.
As you gain more experience and become more comfortable with the volatility of these types of investments, you can gradually increase your allocation.
Risk plays a big role in determining how much to invest in growth stocks. Growth stocks are considered more aggressive and volatile than defensive stocks.
Therefore, a longer time horizon allows more flexibility to tilt your portfolio towards growth investing. If your portfolio makes you anxious, you may want to reduce your exposure to individual growth stocks in favor of more diverse options.
The easiest way to gain exposure to a diverse range of growth stocks is through a fund. Many retirement plans feature growth-focused options that could form the basis of your investing strategy.
For self-directed choices, consider purchasing a growth-based index fund. These funds are ideal investment vehicles because they deliver diversification at lower expenses than mutual funds.
Screening for Growth Stocks
If you’d like to take another step into the do-it-yourself realm, you can buy individual growth stocks. This approach has the highest potential for market-beating returns but carries much more risk than investing in a diversified fund.
To find growth stocks, screen for factors such as above-average growth in earnings per share, above-average profitability, high historical growth in revenue, and high return on invested capital.
Red Flags to Watch Out for
At the same time, you’ll want to watch out for red flags that raise the riskiness of a business.
Examples include a company booking an annual net loss in the past three years, low market capitalization, and recent management shakeups.
Additionally, if sales and/or profitability is falling, it won’t qualify as a growth stock if its core operating metrics are headed lower.
Step 4: Manage your portfolio
Investing in growth stocks can be a profitable endeavor, but it can also be a volatile one. While the goal is to hold on to each investment for several years, you should still monitor significant changes in prices for a few important reasons.
1. Rebalancing Your Portfolio
If a particular holding in your portfolio has grown so much in value that it dominates your portfolio, it may be time to rebalance your portfolio. Rebalancing involves selling some of your top-performing stocks to reduce your exposure and investing in other stocks to maintain a well-diversified portfolio.
2. Selling Overvalued Stocks
If a stock’s price has risen significantly above its estimated value, it might be time to consider selling it. Selling overvalued stocks can help you realize your profits and redirect your funds towards other investments that are more reasonably priced.
3. Selling Underperforming Stocks
If a company has encountered significant challenges that have broken your original investment thesis, it may be time to consider selling it. Examples of a broken thesis include major management missteps, long-term decline in pricing power, or disruption by lower-priced competitors.
Other reasons may arise that could warrant making adjustments to your portfolio by selling stocks. However, assuming that you did your homework when you initially purchased your stocks, in most cases, your job will amount to sitting still and being patient. Allow the power of compounding returns to grow to its full impact on your portfolio over the next 10, 20, or 30 years and more.
Remember that investing in growth stocks is a long-term game, so it’s essential to keep a level head when making decisions.