People have many different styles and tastes when it comes to money, but making your money grow is typically considered the most fundamental investment objective. The best way to accomplish this goal will vary according to factors such as the investor's risk tolerance and time horizon. But there are some principles and techniques that are applicable for many different types of investors and growth strategies.
What Is Growth Investing?
Although you can grow your money through receiving any type of return on your capital, such as interest payments from a CD or bond, a more specific definition of growth investing is the pursuit of increasing one's wealth through long- or short-term capital appreciation. Growth investing is typically considered to be the "offensive" portion of an investment portfolio, with the "defensive" portion dedicated to income generation, tax reduction or capital preservation. When it comes to stocks, "growth" means that the company has substantial potential for capital appreciation, as opposed to value investing, where analysts feel that the price of the company's stock is trading below where it should be for temporal reasons that are likely to change in the foreseeable future. Morningstar classifies all stocks and stock mutual funds as growth, value or blended (growth + value) investments.
Types of Growth Investments
A few main categories of assets have historically shown the greatest growth potential. All of them involve equity in some form, and they usually come with a higher level of risk. Types of growth investments include the following:
The size of a company is based on its market capitalization, or net worth. There is no exact, universal definition of what is considered to be "small cap" compared to micro, mid or large cap, but most analysts classify any company with a capitalization of between $300 million and $2 billion as a small-cap firm. Companies in this category are often still in their initial phase of growth and their stocks have the potential for substantial appreciation in price. Small-cap stocks have historically posted higher returns than their blue-chip cousins, but they are also considerably more volatile and carry a higher degree of risk. Small-cap stocks have also often outperformed large-cap stocks during periods of recovery from recessions.
Technology and Healthcare Stocks
Companies that develop new technologies or offer innovations in healthcare can be excellent choices for investors who are looking for a home-run play in their portfolios. The stocks of companies that develop popular or revolutionary products can rise exponentially in price in a relatively short period of time. For example, the price of Pfizer was just under $5 a share in 1994 before Viagra was released. This blockbuster drug took the company's stock price to above $30 a share over the next five years, thanks to FDA approval of the drug in 1998.
Thrill seekers and speculators look to high-risk growth instruments such as penny stocks, futures and options contracts, foreign currency and speculative real estate such as undeveloped land. There are also oil and gas drilling partnerships and private equity for aggressive investors in high income brackets. Those who pick the right choices in this arena can see a return on capital of many times their initial investment, but they can also often lose every cent of their principal.
Basic Concepts of Growth Investing
There are several key factors that must be considered when evaluating investment growth. The rate of growth, the amount and type of risk and other elements of investing play a substantial role in the amount of money that investors walk away with. When it comes to stocks, some of the data that growth investors and analysts examine include the following:
Return on Equity (ROE)
ROE is a mathematical expression of how efficiently a corporation can make a profit. It is quantified as a percentage that denotes the company's net income (which in this case means the income remaining after the preferred stockholders have been paid but before the common stock dividends are paid) divided by the total equity of the shareholders. For example, if one corporation has total shareholder equity of $100 million while another company has shareholder equity of $300 million and both companies have net income for the year of $75 million, then the company with the smaller shareholder equity is providing a greater return on equity because it is earning the same net income with less equity.
Increasing Earnings Per Share (EPS)
Although there are several types of EPS and the amount of money earned on a per-share basis does not tell the whole story about how a company is run, a company whose earnings per share are increasing over time is probably doing something right. Investors often seek companies that have an increasing EPS, but further research should be done to ensure that the EPS numbers are the result of genuine cash flow from legitimate business dealings.
Many day traders and short term investors pay close attention to projected earnings announcements because they can have both immediate and future effects on a company's stock price. In fact, many investors make money trading earnings announcements. For example, when a company's projected earnings come in higher than expected, then the stock price will often rise quickly and then trend back down in the following days. But consistent positive projected earnings reports will help the stock to rise over time.
The Bottom Line
Growth investing is a complex subject that is often closely coupled with other subjects such as fundamental analysis, technical analysis and market research. There are many more growth strategies used by individual and institutional investors, and a complete listing of them is far beyond the scope of this article. For more information on growth strategies for your investments, consult your broker or financial advisor.