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Growth Investing Comments

John Gazy   |   April 04, 2008
Growth investing is an investment strategy that seeks to increase capital by investing in stocks the investor believes will increase in value, regardless of the stock's current price relative to its underlying value. Growth is often discussed in contrast to value investing. Generally, growth stocks are shares of companies whose earnings are expected to grow at an above-average rate compared to their industries or the overall market, even if they seem to be a bit overpriced in terms of metrics such as price-to-earning or price-to-book ratios.

A growth company tends to have very profitable reinvestment opportunities for its own retained earnings. Thus, it typically pays little or no dividends to its stockholders, opting instead to plow most or all of its profits back in expanding business. They are most often seen in the technology industries. Google is perhaps one of the most representative examples of growth companies. Growth companies such as Google are expected to increase profits in the future, and thus the market bids up their share prices to high valuations.

As previously mentioned, growth investors are concerned with the company's future growth potential. However, there is no formula for calculating the stock's potential growth. Investors have to analyze the stock�s performance by first closely looking into its industry or sector. Here are some common criteria for evaluating the stock�s potential growth.

Strong historical earnings growth.
It is impossible to accurately forecast the future without first knowing the past. Even knowing the past is not a guarantee that the future holds up the same outcome. However, it is not going to hurt to know about the company's historical earnings. Investors should look closely at the company�s earnings per share (EPS) to see whether the company shows any growth in the past. Typically, companies� earnings grow by 7-12 percent annually depending on their market capitalization.

Strong earnings growth in future. An investor is not going to miss a chance of investing in a stock whose future annual growth is estimated to grow at 15% over the next five years. Again, such estimates are not guaranteed by experts, and thus should not be fully relied upon. It is always worth checking various sources to get the most accurate numbers.

Efficient management. You can easily calculate the efficiency of management operation by using return on equity (ROE). Efficient use of assets should be reflected in a stable or increasing ROE.

Many analysts argue that growth investing contrasts with the strategy known as value investing. However, some investors, including the well-known Warren Buffett, state that there is no theoretical difference between the two strategies. �Growth and value investing are joined at the hip�, he says. Another very famous investor, Peter Lynch, pioneered a hybrid of growth and value investing with what is now commonly referred to as a �growth at a reasonable price (GARP)� strategy, which resulted in his financial success.

Most analysts and financial advisers believe that growth investing is not efficient any more as value stocks systematically outperform growth stocks. Indeed, value stocks showed great performance for the last five years, but you shouldn�t be so categorical. There were periods when growth investing was much more efficient than value investing (1982, 1985, 1987, 1989-91, 1995-99).

Personally, I believe that diversifying your portfolio with both growth and value stocks could be the most logical strategy. Enjoy your trading.
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