For some of us, the world of investing is filled with terminology that may either confuse us or potentially deter us from parting with our cash. Such is the complexity, that even though the reward can often be high, the doubts and lack of understanding can make people hold back.
Terms such as income, growth, gearing, compound interest and more are all second nature to more seasoned investors, but to those just diving in, it often pays to understand a little more about it. As a result, it can be worth explaining such terms a little more, and in this blog, we take a look at growth investing. What does it mean if you are investing for growth, and what are the risks, rewards and things you should be aware of?
What does growth in investing mean?
If you have seen the term growth when reading or hearing about investments, you’ll be learning that investments can pose high levels of risk. However, they can also deliver high levels of reward.
Growth investing is a form of investment strategy where an investor aims to increase the value of their capital, normally by investing in companies that are perhaps less established than others in their sector but have the potential to see earnings increase at a rate faster than others in that area or on the market as a whole. Of particular interest to many growth investors are tech and healthcare companies.
It can be a risky strategy, as with these companies unproven, there is every chance the value never increases much at all. Or, in the worst case, the company folds and your investment becomes worthless. However, these are often great opportunities for investors too. Stock is often cheaper to buy and can accelerate upwards fast, delivering a very profitable investment if the company is a success.
So how does growth investing work?
As mentioned earlier, those looking to invest where an opportunity for growth can be spotted will often look to new companies that are relatively small but appear to have great long-term potential. An investor will look for such an opportunity in industries that are rapidly expanding. As we referenced earlier, technology will always be one for this. But, with so many tech companies in operation, it can be hard to know who really has that new, innovative product or service that could see them jump ahead of the competition.
If you are investing for growth, you don’t look for an income through regular dividend payouts. Instead, you look at selling the shares when the value has risen significantly. This is known as capital appreciation.
In many instances, the companies being invested in by growth investors may not have even made a penny yet. Some may hold the key to revolutionary tech that has been granted a patent or a product that needs to be timed just right for a launch to mass market.
This can be a slow burner in terms of generating wealth, especially if companies haven’t launched a product or turned a significant profit yet, but through constant reinvestment of profits, they can develop these groundbreaking technologies and remain ahead of the competition, increasing their worth to both customers and investors.
How can you determine a company is an investment for growth?
For those new to investing you may be surprised to know, no crystal ball shows you whether your investment is going to be a complete success. Much comes down to your belief in the business and understanding a few key elements that may determine how that business will perform.
Constant growth in earnings
If you are looking to invest in a company for growth, you want to see that it has performed well in the short period it has been in operation. Remember, a company that has been around for ten years is still new when compared to many big players within the same industry. The growth should be continuous, but it should also be resplendent of the size of the company. If the company is worth ?100m and shows just 1% growth, it’s not necessarily performing as well as a company worth ?20m that has shown a 7% rate of earnings per share growth each year.
Continual strength in earning
If earnings estimates remain consistent, and analysts predict that the market or the company will continue to grow at a faster-than-average rate, it’s a sign that the company is still moving forward and not stalling. This makes for a good investment potentially.
Good margins
Turnover means nothing if there is no profit at the end of it. A business could turn over ?300m this year, but if operating costs exceed this, then there is not much to shout about. This is of particular importance to those looking for growth investments, as sales growth may be incredible for this business but if there are no earnings for it to show, then the company isn’t really growing at all. It’s being managed poorly.
The rule of thumb is that if the company exceeded pre-tax profit margins for the previous five years, it could be a worthy investment opportunity.
Returns on equity
The return on equity is the measure that shows how much profit has been generated with shareholders’ money. The current ROE should be compared to the five-year average ROE for both the company and the industry it is in. If the result is that the ROE is stable, or on its way upwards, it would indicate the business is in good hands, which could be a key indicator for future performance.
Stock performance
A company that is growing should be seeing its stock double in five years. If it’s not, it is not a growth investment. In emerging and rapidly developing industries a growth of 15% in five years would mean it’s doubled, and that is an amount seen as perfectly achievable for companies operating in such spaces.
How do I start investing for growth?
Once you have carried out the above research into the companies you feel could be worthwhile, you can either opt for professional advice or go it alone. With the research you have completed, you may want the backing of an investment expert to help back up your findings. This way you may feel a little more confident diving right in. Alternatively, if you feel comfortable with the knowledge you have given yourself, you could look for a fund that such companies are held in and invest through that. It would always be advisable to seek advice though, investments can go up as well as down and a positive return is never guaranteed.
