Growth investing focuses on finding companies that are expected to grow faster than the overall market. While value investors hunt for bargains, growth investors seek companies with strong revenue and earnings momentum, willing to pay premium prices for exceptional growth potential. This guide will show you how to identify and evaluate growth stocks for your portfolio.
What is Growth Investing?
Growth investing is an investment strategy that focuses on capital appreciation. Growth investors buy stocks of companies expected to grow at an above-average rate compared to their industry or the overall market. These companies typically reinvest their earnings to accelerate expansion rather than paying dividends.
The growth mindset: Growth investors believe that companies with strong revenue and earnings growth will see their stock prices rise over time, regardless of current valuations. They prioritize future potential over present value.
Characteristics of Growth Stocks
High Revenue Growth
Growth companies typically show revenue growth rates of 15-25% or more annually. They operate in expanding markets and consistently gain market share. Look for companies with accelerating revenue growth, not just steady growth.
Strong Earnings Growth
While some growth companies sacrifice short-term profits for long-term expansion, the best growth stocks show improving profit margins alongside revenue growth. Earnings per share (EPS) growth of 15% or higher is a common benchmark.
Innovative Products or Services
Growth companies often lead their industries in innovation. They develop new products, enter new markets, or disrupt existing industries with better solutions. Think of how Amazon revolutionized retail or how Tesla transformed the auto industry.
Competitive Advantages
Sustainable growth requires a competitive moat. This could be proprietary technology, network effects, brand recognition, or economies of scale that protect the company from competitors.
Key Metrics for Growth Investors
Essential Growth Metrics
- Revenue Growth Rate: Year-over-year revenue increase (look for 15%+ annually)
- Earnings Growth Rate: Year-over-year EPS increase (look for 15%+ annually)
- PEG Ratio: P/E ratio divided by earnings growth rate (under 1.0 may indicate undervaluation)
- Price-to-Sales (P/S): Useful for companies not yet profitable
- Return on Equity (ROE): Measures how efficiently the company uses shareholder equity
- Gross Margin: Higher margins indicate pricing power and efficiency
How to Find Growth Stocks
1. Industry Analysis
Start by identifying industries with strong tailwinds. Technology, healthcare, renewable energy, and e-commerce have historically produced many growth stocks. Look for sectors benefiting from long-term trends like digital transformation, aging populations, or sustainability.
2. Financial Screening
Use stock screeners to filter for companies with:
- Revenue growth above 15% annually for the past 3-5 years
- Earnings growth above 15% annually
- Expanding profit margins
- Strong return on equity (above 15%)
- Manageable debt levels
3. Competitive Position Analysis
Evaluate whether the company can sustain its growth. Ask yourself:
- Does the company have a defensible market position?
- Is there a large addressable market for further growth?
- Can competitors easily replicate what this company does?
- Is management executing well on its strategy?
4. Management Evaluation
Strong growth companies usually have visionary leadership. Research the CEO and management team:
- Track record of execution and hitting targets
- Alignment with shareholders through stock ownership
- Clear communication of strategy and goals
- Ability to attract and retain top talent
The PEG Ratio Explained
The Price/Earnings to Growth (PEG) ratio is a crucial tool for growth investors. It helps determine whether a high P/E ratio is justified by growth expectations.
PEG Ratio Calculation
PEG = P/E Ratio / Annual EPS Growth Rate
Example: A company with a P/E of 30 and expected EPS growth of 25%:
- PEG = 30 / 25 = 1.2
- A PEG under 1.0 is generally considered attractive
- A PEG between 1.0-2.0 is reasonable for quality growth stocks
- A PEG above 2.0 may indicate overvaluation
Growth Investing Strategies
CANSLIM Method
Developed by William O'Neil, founder of Investor's Business Daily, CANSLIM focuses on:
- C - Current quarterly earnings (up 25%+)
- A - Annual earnings growth (up 25%+ for 5 years)
- N - New products, management, or price highs
- S - Supply and demand (low shares outstanding)
- L - Leader or laggard (buy market leaders)
- I - Institutional sponsorship (smart money buying)
- M - Market direction (buy in uptrends)
Momentum Growth
This approach combines growth fundamentals with price momentum. Investors look for growth stocks that are also showing strong price performance, believing that winning stocks tend to keep winning.
Growth at a Reasonable Price (GARP)
GARP investors seek growth stocks that are not extremely overvalued. They use metrics like the PEG ratio to find companies with strong growth trading at reasonable valuations.
Risks of Growth Investing
- Valuation Risk: Growth stocks often trade at high multiples, making them vulnerable to corrections if growth slows
- Execution Risk: High growth expectations can lead to sharp drops if companies miss earnings targets
- Interest Rate Sensitivity: Rising interest rates often hurt growth stocks more than value stocks
- Competition: High-growth industries attract competitors who may erode market share
- Volatility: Growth stocks typically experience larger price swings than the overall market
Building a Growth Portfolio
Diversification
Even within a growth-focused portfolio, diversify across sectors and market caps. Holding 15-25 growth stocks reduces company-specific risk while maintaining growth exposure.
Position Sizing
Consider limiting individual positions to 5-10% of your portfolio. Higher-risk growth stocks might warrant smaller positions.
Regular Review
Monitor your holdings quarterly. Sell or trim positions when:
- Fundamentals deteriorate (slowing growth, margin compression)
- The stock becomes extremely overvalued
- Better opportunities emerge elsewhere
- Your investment thesis is no longer valid
Monitor Your Growth Portfolio
Pro Trader Dashboard makes it easy to track your growth investments. Monitor revenue growth, earnings trends, and portfolio performance all in one intuitive dashboard.
Famous Growth Investors
- Peter Lynch: Legendary Fidelity manager who averaged 29% annual returns
- Philip Fisher: Author of "Common Stocks and Uncommon Profits"
- William O'Neil: Creator of the CANSLIM system
- Cathie Wood: Founder of ARK Invest, known for disruptive innovation focus
- T. Rowe Price: Pioneer of growth investing in the 1930s
Summary
Growth investing focuses on finding companies with exceptional revenue and earnings growth potential. While these stocks often trade at premium valuations, their strong fundamentals can lead to significant capital appreciation over time. Success requires thorough research, patience through volatility, and discipline in selling when fundamentals change. Combine growth investing with proper diversification and risk management for the best results.
Want to explore other strategies? Read our guide on value investing or learn about momentum investing.