The success (or failure) of your business is heavily dependent on the investment plan you choose. The growth investment strategy is one of the most common approaches taken by investors.
The technique is based on identifying and investing in stocks that have shown impressive growth in the recent past and capitalizing on their potential for future growth. A good growth stock, then, what does that even mean?
The Best Growth Stocks’ Characteristics
You should look for stocks with the following characteristics if you want to make money from the upward volatility and take advantage of their potentially massive growth.
- Stock Price Increase
A stock is considered a growth stock if its share price is increasing over time. The stock does not qualify because it has not increased in value.
But how do you know if a stock is rising? Looking at a stock chart is the quickest and most straightforward option.
- Review stock charts that span three months and one year. Looking at the chart, you can tell if a stock is rising or falling. A good indicator that a stock is a growth stock is whether or not the price of its shares has been trending upwards over the past year.
- A review of the chart for the past three months and one year is essential. You can evaluate if the stock’s rise has been sustainable over the long term by looking at the one-year chart and the three-month chart to see if the trend is now rising.
- Pardon Dips. Stocks that have been rising will occasionally fall when investors take profits or process fresh information, and this occurs even in bull markets. You should focus on the long-term trend of the data and discount any temporary dips that may occur.
- Analyze the Growth in relation to the S&P 500. The Standard & Poor’s 500 index is widely regarded as the best indicator of general market performance in the United States. You can tell if a company’s stock has underperformed, performed similarly to, or outpaced the broader U.S. market by comparing its growth to the S&P 500’s growth over the past three months and one year. After all, you’re on the hunt for high-growth stocks that can beat the market’s average returns.
After analyzing the stock’s performance over the past three months and one year, you may be confident that you have found a good opportunity to outperform the market.
- Earnings Growth
Only if the company’s profits continue to rise over time can the stock price rise steadily. Who would want to keep pouring money into a failing business?
Nasdaq provides a useful tool that makes calculating earnings growth a breeze. Find the tool by visiting Nasdaq’s website and searching for the ticker of the stock you’re interested in. There is a link labeled Earnings on the left side of the profile for each stock.
A graph detailing quarterly earnings per share over the past year will appear on the resulting page. Gains in profitability should be sustained from quarter to quarter. Consider the earnings shocks as well. Earnings surprises that are always favorable are a strong indicator of a growing company’s stock price.
- Increased Revenue
A stock’s revenue growth history is just as crucial as the company’s reputation for safety. It is possible to increase profits while experiencing flat or declining income by cutting expenses. Earnings will eventually decline if these strategies are used for too long without underlying revenue growth.
Make sure the stocks you’re considering have been showing steady and impressive revenue growth.
You can check the company’s revenue growth by reviewing the last four quarters of its financial reports. Keep an eye on quarterly revenue reports, keeping in mind the typical industry ups and downs.
For instance, the fourth quarter of the year is typically the most profitable for technology firms because of the seasonally engaged customer base. Therefore, it is possible for companies in this industry to see a sales plateau or even fall from the fourth quarter to the first quarter. This would be fine as long as revenues increased sequentially during the remainder of the year.
- Market Growth
I think you’re starting to see a pattern here. Finding a stock with consistent growth across multiple criteria is essential for growth investors, but you shouldn’t focus solely on the stock itself or the company it represents.
The capacity to attain continuous gains in revenue, profitability, and share price depends critically on the growth of the addressable market the firm you’re interested in targets.
A company may be experiencing rapid expansion if it is gaining a larger share of the market it serves, but this expansion won’t be sustainable if the market size stays the same. One day, the company will reach a position of self-sufficiency when the market is fully penetrated.
Therefore, it is crucial to investigate market data to ascertain if the market in which the company operates is developing at a rate capable of supporting ongoing upward movement in the stock you are investing in.
Simply visit your preferred search engine, enter “(industry) market size,” and read through the resulting content to gain insight. In most situations, a number of statistical organizations have conducted in-depth studies of the industry, quantifying its current size and projecting its future growth.
Look at how much of the market the company has already penetrated to see how much space for growth there is if it operates in a stagnating market.
- Growth in Free Cash Flow
Businesses are like rivers in which money constantly enters and leaves. When all cash outflows are subtracted from cash inflows, the remaining amount is a company’s free cash flow. Free cash flow is distinct from profitability since it ignores intangible costs like depreciation.
Make sure that free cash flow is increasing steadily. Checking the financial statements of the firm over the course of the last four quarters will reveal this.
- A Reasonable Price
Following significant price appreciation, growth stocks are notorious for reaching extreme overvaluations that can trigger dramatic price declines as investors sell their shares to realize their profits. Even while a reasonable valuation should be anticipated on average, the risk becomes more significant when prices suddenly skyrocket.
Stocks can be evaluated for their current undervaluation, overvaluation, or fair pricing using the P/E ratio. Value investors frequently make use of the price-to-earnings (P/E) ratio, which is calculated by dividing the stock price by the per-share earnings of a firm in its most recent fiscal year.
The average ratio will vary depending on the market. You can determine whether or not the stock’s current price is fair by comparing it to similar companies in the same industry.
- A Solid Balance Sheet
It’s more of a matter of doing your homework as an investor in general and has little to do with expanding your business. When investing in a stock, it is important to verify that the underlying company has a healthy balance sheet.
The balance sheet will show the total worth of the company’s assets and liabilities, providing you an overview of the firm’s financial health.
- Clear Competitive Advantages
A company’s success requires distinct advantages over its rivals. Examine the smartphone industries of both BlackBerry and Apple, for instance.
It’s not hard to see that BlackBerry was ahead of the curve, given it produced some of the very first cell phones. As more and more rivals entered the market, BlackBerry’s market share steadily declined until consumers began referring to the brand as “Black-What?”
In contrast, Apple entered the market with a distinct advantage. The firm routinely introduced novel approaches to using mobile devices, and it assembled an ecosystem that included an app store, a music streaming service, and more. Even if there are many other options available, many Apple smartphone consumers still refuse to move to other devices because of the superior experience provided by Apple. Apple is therefore considered a top growth stock in the market.
- A Solid Management Team
A company’s team is like a chain; it’s only as strong as its weakest link, which may often be found in upper management.
When you put money into a company, you’re putting your faith in the management team to make decisions that will boost the firm’s success.
Why put your faith in a group whose members you have no personal knowledge of?
You should learn as much as possible about the firm’s top executives before deciding to buy stock in the company.
How long have team members been with the organization, and what have they accomplished since assuming their current roles? If they’ve worked together previously, where, and did they have any success there, it’s important to know.
You need to have the answers to these questions at the ready.
- Prospects for Future Growth
One last thing to consider before investing in a company’s stock is the company’s long-term growth potential, especially if you plan on selling the shares at a profit in the near future. When thinking about its future growth and development, what is its backstory?
For instance, the manufacturing of clean fuels by the company Gevo is a popular issue among growth investors. As a result of the company’s recent signing of multiple agreements, investors are optimistic about the company’s future revenue prospects. The corporation is also making efforts to improve its infrastructure in order to keep up with rising customer demand. Investors are optimistic about the company’s future because of the positive developments going on within it.
Any growth stock you buy should have solid plans for future expansion, whether that’s into new markets, wider distribution channels, or the introduction of innovative new goods.
Consider buying Growth ETFs
Identifying and capitalizing on market expansion prospects is sometimes a time-consuming and laborious task. If you don’t have the time to spend on the process, or the skill it takes to investigate each and every investment possibility before risking your money, you may want to explore investing in exchange-traded funds (ETFs) with an emphasis on growth methods instead of buying individual stocks.
Although investing in growth-focused funds will lessen the amount of research required, it’s still important to look into each fund’s history performance, expense ratio, and dividend yield before plunging in.
Growth stock investing has the potential to be a highly profitable endeavor. Growth investment is favored by both individual and institutional investors due to its potential for outperforming the market.
Research is the backbone of a good investment strategy, as it is with any other type of investment. If you take the time to investigate and verify that the stocks you’re considering for investment have the aforementioned qualities, you’ll considerably improve your chances of making a profit.