Growth Investing Strategy

Growth investing focuses on companies with above-average earnings or revenue growth, even if current valuations seem high. It's based on the belief that growth justifies premium prices. [DEFINITION] Growth Investing: An investment strategy focused on stocks expected to grow earnings, revenues, or cash flows faster than the market average, often trading at premium valuations. ### Growth Investing Principles **Core beliefs:** - Exceptional companies deserve premium prices - Revenue growth is the primary driver - Today's expensive may be tomorrow's bargain (if growth continues) - Compound growth creates enormous wealth [KEY] A company growing earnings 20% annually doubles in less than 4 years. That potential justifies paying more today. ### Growth Stock Characteristics **High growth rates:** - Revenue growing 15%+ annually - Earnings growing 20%+ annually - Market share expanding **Reinvestment:** - Minimal or no dividends (reinvesting in growth) - High R&D spending - Expanding into new markets **Premium valuations:** - P/E ratios often 30-100x+ - Price-to-Sales ratios often 5-20x - Value based on future, not current earnings [EXAMPLE] Amazon traded at P/E of 100-200x+ for most of its history. Growth investors who focused on revenue growth, market share, and optionality saw the stock rise from $15 to $3,500+ (split-adjusted). ### Identifying Great Growth Stocks **CANSLIM criteria (William O'Neil):** - **C**urrent quarterly earnings (up 25%+) - **A**nnual earnings growth (25%+ for 5 years) - **N**ew products, management, or highs - **S**upply and demand (low float, high volume) - **L**eader in industry - **I**nstitutional support - **M**arket direction (bull market) ### Risks of Growth Investing [WARNING] Growth stocks carry significant risks: - High expectations = severe punishment for misses - Valuation compression if growth slows - Often first to crash in bear markets - Many growth stories end badly (hype vs. reality) **Historical cautionary tales:** - Pets.com (2000): Great story, no economics - GoPro (2015): Growth stalled, stock -90% - Peloton (2021): COVID surge reversed, stock -95% ### Growth at a Reasonable Price (GARP) **Hybrid approach:** - Seek growth but with valuation discipline - Use PEG ratio: P/E ÷ Growth Rate - PEG under 1.0 = potentially attractive [FORMULA] PEG Ratio = P/E Ratio ÷ Expected Annual EPS Growth Rate [EXAMPLE] Stock A: P/E 30, Growth 30% = PEG 1.0 Stock B: P/E 30, Growth 15% = PEG 2.0 Stock A offers better value for its growth. ### Selling Growth Stocks When to consider selling: - Growth rate slowing significantly - Competition intensifying - Management changes - Valuation becomes absurd even for growth - Story changes fundamentally [TIP] The best growth stocks compound for years. Don't sell just because the price has doubled—focus on whether growth continues. [EXERCISE] A stock trades at P/E of 50x with EPS growth of 40% annually. Calculate the PEG ratio. Is this expensive or reasonable for a growth stock? |ANSWER| PEG = 50 ÷ 40 = 1.25. This is in the reasonable range for a quality growth stock (PEG under 1.5 is generally acceptable). If the company can maintain 40% growth, the current price may look cheap in a few years. [SCENARIO] You bought a growth stock at P/E 40 when it was growing 35% annually. Two years later, growth has slowed to 15%, but the stock has tripled and P/E is now 60. Should you sell? Probably. The growth rate nearly halved while valuation expanded. The risk/reward has shifted significantly. With 15% growth, a P/E of 60 is very stretched (PEG = 4.0). Taking profits makes sense. If growth reaccelerates, you can always return. Holding a decelerating growth stock at premium valuations is one of the most common mistakes in growth investing.