Growth investing focuses on finding companies that are expanding faster than the overall market. These companies reinvest their profits to fuel expansion, often sacrificing current dividends for future gains. In this guide, we will explain how growth investing works and how to identify stocks with exceptional growth potential.
What is Growth Investing?
Growth investing is an investment strategy centered on capital appreciation. Growth investors buy shares in companies they believe will grow revenues, earnings, or cash flows at rates significantly above the market average. The goal is to buy these companies before their full potential is recognized and profit as they expand.
The simple version: Find companies growing fast and buy them before everyone else catches on. You accept paying premium prices today for the potential of much higher earnings tomorrow.
Characteristics of Growth Stocks
Growth stocks typically share several common characteristics:
- Above-average revenue growth: Usually 15-25% or higher annually
- High P/E ratios: The market pays a premium for expected future growth
- Little or no dividends: Profits are reinvested in the business
- Innovative products or services: Often disruptive to existing industries
- Strong competitive advantages: Network effects, switching costs, or brand loyalty
- Large addressable markets: Room to grow for many years
Key Metrics for Growth Investors
1. Revenue Growth Rate
The most fundamental growth metric. Look for companies with consistent double-digit revenue growth over multiple years, not just one good quarter.
Example
Company A's revenue over 5 years:
- Year 1: $100 million
- Year 2: $130 million (+30%)
- Year 3: $169 million (+30%)
- Year 4: $220 million (+30%)
- Year 5: $286 million (+30%)
This consistent 30% annual growth rate signals a strong growth stock candidate.
2. PEG Ratio (Price/Earnings to Growth)
The PEG ratio helps determine if a growth stock is reasonably priced relative to its growth rate. Divide the P/E ratio by the expected earnings growth rate.
Example
Company B has a P/E of 40 and expected earnings growth of 40%.
- PEG = 40 / 40 = 1.0
- A PEG of 1.0 suggests fair value for growth
- PEG below 1.0 may indicate undervaluation
- PEG above 2.0 may signal overvaluation
3. Total Addressable Market (TAM)
A company's growth potential depends on how large its market opportunity is. A small company in a massive market has more room to grow than a large company in a small market.
4. Gross and Operating Margins
Improving margins alongside revenue growth is a powerful combination. It shows the company is gaining operating leverage as it scales.
How to Find Growth Stocks
- Identify megatrends: Look for secular shifts in technology, demographics, or consumer behavior
- Screen for growth metrics: Filter for companies with 20%+ revenue growth and improving margins
- Analyze competitive position: Does the company have a moat that protects its growth?
- Evaluate management: Founder-led companies often outperform in growth phases
- Check the financials: Strong balance sheet to fund growth without excessive dilution
- Assess valuation: Use PEG ratio and compare to peers
Growth Investing Strategies
Pure Growth
Focus exclusively on the fastest-growing companies regardless of valuation. This approach can generate spectacular returns but carries higher risk during market downturns.
GARP (Growth at a Reasonable Price)
Blend growth and value principles by seeking growth companies that are not excessively valued. Look for PEG ratios below 1.5 and sustainable competitive advantages.
Sector-Focused Growth
Concentrate on high-growth sectors like technology, healthcare, or consumer discretionary where growth opportunities are most abundant.
Risks of Growth Investing
- Valuation risk: High P/E stocks can fall dramatically if growth disappoints
- Growth slowdown: All companies eventually see growth rates decline
- Competition: High-growth markets attract competitors who may erode margins
- Interest rate sensitivity: Growth stocks often decline when interest rates rise
- Volatility: Growth stocks typically experience larger price swings than the market
Key insight: The biggest risk in growth investing is paying too much for growth that does not materialize. Always consider what happens if growth slows to average levels.
Famous Growth Investors
Several legendary investors have built their reputations on growth investing:
- Philip Fisher: Author of "Common Stocks and Uncommon Profits," emphasized qualitative factors
- Peter Lynch: Achieved 29% annual returns at Fidelity Magellan Fund
- T. Rowe Price: Pioneer of growth investing, founded the firm bearing his name
- Cathie Wood: Modern growth investor focused on disruptive innovation
Track Your Growth Portfolio
Pro Trader Dashboard helps you monitor your growth stocks, track revenue and earnings trends, and analyze your portfolio's growth characteristics. See which positions are driving your returns.
Building a Growth Portfolio
- Position sizing: Limit individual positions to 5-10% given higher volatility
- Diversify by growth stage: Mix early-stage hypergrowth with mature growth names
- Sector balance: Avoid overconcentration in a single sector
- Rebalance regularly: Take profits from winners that become oversized positions
- Long time horizon: Growth investing works best over 5-10 year periods
Summary
Growth investing can generate market-beating returns by identifying companies with exceptional growth potential before the crowd. Focus on sustainable revenue growth, expanding margins, large addressable markets, and competitive advantages. Be mindful of valuations and maintain realistic expectations about growth rates. With patience and disciplined analysis, growth investing can be a powerful wealth-building strategy.
Ready to learn more? Check out our guide on value investing for a different approach, or explore momentum investing strategies.