Growth investing focuses on companies that are expanding revenue, earnings, and market share faster than average. These companies reinvest profits into growth rather than paying dividends, offering the potential for significant capital appreciation. Here is how to screen for high-quality growth stocks.
What Defines a Growth Stock?
Growth stocks are characterized by above-average revenue and earnings growth, expanding profit margins, and large addressable markets. They often trade at premium valuations because investors are willing to pay more for future growth potential. The best growth stocks combine rapid growth with improving profitability.
Growth investing principle: The goal is to find companies in the early stages of a long growth runway. A company growing at 25% annually for 10 years will increase 9x in size, potentially delivering massive returns.
Essential Growth Screening Criteria
Revenue Growth
Revenue is the foundation of growth:
- Minimum 15% YoY: Baseline for growth stock status
- 20-30% YoY: Strong growth territory
- 30%+ YoY: Hypergrowth (often smaller companies)
- Consistent growth: Growing each of last 3 years
Earnings Growth
Earnings growth should match or exceed revenue growth:
- EPS growth > 20%: Strong earnings expansion
- EPS growth > revenue growth: Expanding margins
- Positive earnings: Preferably profitable now
- Analyst estimates rising: Positive estimate revisions
Quality Growth Screen
Revenue growth > 20% YoY
EPS growth > 20% YoY
Gross margin > 50%
Market cap > $1 billion
Positive free cash flow
PEG ratio < 2.0
This screens for profitable, rapidly growing companies at reasonable valuations.
The PEG Ratio
The Price-to-Earnings-Growth ratio is essential for growth stock valuation:
- PEG = P/E divided by EPS growth rate
- PEG under 1.0: Potentially undervalued growth
- PEG 1.0-2.0: Fair value for growth
- PEG over 2.0: Premium valuation
Example: A stock with P/E of 40 and growth rate of 40% has PEG of 1.0 - fairly valued despite high P/E.
Quality Indicators
Not all growth is equal. Look for quality growth:
Margin Expansion
- Gross margin > 40%: Pricing power and competitive advantage
- Operating margin improving: Operating leverage kicking in
- Net margin trending up: Profitability scaling
Return Metrics
- ROE > 15%: Efficient use of equity
- ROIC > 12%: Creating value with invested capital
- Improving trends: Returns getting better, not worse
Market Position Filters
Competitive Advantage
Growth stocks need defensible positions:
- Market leader: #1 or #2 position in their niche
- Growing market share: Taking share from competitors
- High switching costs: Customers unlikely to leave
- Network effects: Product gets better with more users
Addressable Market
- Large TAM: Total addressable market > $10 billion
- Low penetration: Company has captured < 10% of market
- Growing market: Industry itself is expanding
CAN SLIM Growth Criteria
William O'Neil's famous growth investing framework:
- C - Current earnings: Up 25%+ in most recent quarter
- A - Annual earnings: Up 25%+ each of last 3 years
- N - New: New product, management, or price high
- S - Supply/demand: Strong volume on up days
- L - Leader: RS rating above 80
- I - Institutional: Increasing fund ownership
- M - Market: General market in uptrend
Growth at Reasonable Price (GARP)
A balanced approach combining growth and value:
- Revenue growth > 15%
- EPS growth > 15%
- PEG ratio < 1.5
- P/E < 25
- Debt-to-equity < 1.0
GARP philosophy: Why pay 50x earnings for a 20% grower when you can find a 20% grower at 20x earnings? Seek the intersection of growth and value.
Warning Signs in Growth Stocks
Avoid these red flags:
- Decelerating growth: Growth rate slowing quarter over quarter
- Revenue growth from acquisitions: Not organic growth
- Massive stock-based compensation: Diluting shareholders
- Customer concentration: Too dependent on few customers
- Insider selling: Executives dumping shares
- Guidance cuts: Management lowering expectations
Comprehensive Growth Screen
A complete growth stock screener:
- Market cap > $1 billion
- Revenue growth (YoY) > 20%
- Revenue growth (3-year avg) > 15%
- EPS growth (YoY) > 20%
- Gross margin > 45%
- Operating margin > 10% (or improving)
- PEG ratio < 2.0
- RS rating > 70
- Price within 25% of 52-week high
- Average volume > 500,000
Growth Stock Risk Management
Growth stocks are volatile. Manage risk by:
- Position sizing: Smaller positions in high-growth names
- Stop losses: Cut losses at 7-8% below purchase price
- Sell rules: Exit when growth decelerates significantly
- Diversification: Own 10-15 growth names across sectors
Track Your Growth Portfolio
Pro Trader Dashboard helps you monitor your growth stock positions. Track performance, analyze winners and losers, and refine your strategy.
Summary
Growth stock screening focuses on companies with strong revenue and earnings growth, expanding margins, and large market opportunities. Use the PEG ratio to ensure you are not overpaying for growth. Look for quality indicators like improving margins and high returns on capital. Watch for warning signs like decelerating growth and heavy insider selling. Remember that growth stocks are volatile, so proper position sizing and stop losses are essential for long-term success.
Learn more: dividend vs growth stocks and fundamental analysis.