What is a Growth Industry?
A growth industry is that sector of an economy which experiences a higher-than-average growth rate as compared to other sectors. Growth industries are often new or pioneer industries that did not exist in the past. Their growth is a result of demand for new products or services offered by companies in the field. An example of a growth industry is the technology sector, whose products have become runaway hits with consumers and led to multibillion dollar valuations for tech companies in the stock market.
Understanding Growth Industries
Several factors are responsible for catalyzing a growth industry.
One of them is the advent of new and innovative technologies which can drive entrepreneurs and startups to develop new products and services related to the industry. Given the constantly changing nature of technology, the rationale behind investing in such technologies is the promise of exponential future growth.
The smartphone industry, which packed multiple innovative technologies into a single phone, became a growth industry during the earlier part of this decade. In recent times, virtual reality (VR) and machine learning are two examples of such an approach. VR is an immersive, computer-generated scenario that can simulate a real-life experience. It has applications across many industries, from VR headsets for gaming to simulations for driving tests and for learning in medical schools.
Big data involves the processing of large amounts of data for research or to identify trends and statistical probabilities. Companies in big data provide services to large corporations or industries, such as healthcare. Startups and companies in the sector have multiplied as the technology becomes popular. Investors typically value companies at a multiple of their current earnings and their future growth potential.
Change in regulations can also spur growth. For example, growth in the healthcare industry is mostly driven by changes in regulation relating to insurance. The deregulation of electricity markets and greater awareness about sustainable living has also led to investors putting their money into stocks for solar companies and renewable energy companies. Medical marijuana is another growth industry that came into being due to the relaxing of strict marijuana laws.
Tesla, Inc. (TSLA), which has among the highest valuations of car companies, is an example of a company that benefits from changing regulations and its technology chops. Investors have flocked to the company due to its promise of a greener future as well as its cars, which incorporates state-of-the-art technology.
A third factor driving growth industries is a change in lifestyle and consumer preferences. With more leisure time and availability of technology and transportation options, consumers have begun traveling more. Travel apps and websites have proliferated. Travel-related startups, such as Airbnb and Uber, have garnered record valuations in private markets and are considered hot commodities for public markets.
- Growth industries are sectors of economies that experience higher-than-average growth due to new technologies or changes in societal preferences or government regulations.
- While they can be volatile and risky stocks, companies in growth industries are generally accompanied by press hype and steadily increasing sales figures.
- Analysts use CAGR to value growth industries.
Characteristics of Growth Industries
Particular characteristics of growth industries include companies across an industry exhibiting consistent and quickly growing sales figures and an influx of investments. This can often be accompanied by a lot of press hype. Growth industries tend to be composed of relatively volatile and risky stocks. Often investors are willing to accept increased risk in order to take part in the potentially large gains.
Additional risks that growth industries pose can include high rates of cash burn, lack of profitability despite consumer and investor excitement, bubbles, and technological setbacks that can obstruct progress.
Growth Industries and CAGR
Many analysts use the compound annual growth rate (CAGR) when determining the present viability and future potential of an investment. The CAGR is the mean annual growth rate of an investment over a set period of time longer than one year and can apply to companies in both growth and regular industries.
To calculate compound annual growth rate, analysts divide the value of an investment at the end of the period by its value at the beginning of the period. The analyst then raises the result to the power of one, divided by the period length, and subtract one from the subsequent result:
CAGR is widely used to calculate the average growth of an investment. An investment may increase in value by 6% in one year, decrease in value by 3% the following year and increase again by 2% in the next. With inconsistent annual growth, CAGR may be used to give a broader picture of an investment’s progress; however, it doesn’t take into account external factors such as market volatility.
Example of a Growth Industry
The marijuana industry has become an example of a growth industry in recent times. Marijuana had a bad reputation and its possession and use was heavily-regulated in the country. The situation has changed in the last decade as a groundswell of popular opinion has led to lawmakers changing their prohibitive stance on the plant. As of January 2019, 33 states have legalized medical marijuana and its use and possession is legal in 10 states. Universities are conducting research into its uses and applications to medical science. For example, New York University researchers are using it to treat incoming veterans with PTSD. Food entrepreneurs and beverage companies are infusing their products with marijuana chemicals. Investors have poured money into marijuana companies on growth expectations for the future.