The main aim of turning to the stock market for long-term investments is to grow your wealth enough to fulfill long-term goals like retirement or your child’s higher education. However, for this, the first thing necessary is strategic growth investing. How to do that? And how do we know which stocks will give the desired returns in the long run? Let’s understand.
What is growth investing?
Growth investing focuses on increasing your capital by investing in stocks of small, new companies with high growth potential. But the question is, how high a growth? In growth investing, you target companies expected to grow in all aspects at an above-average rate than their industry or the overall market.
Investing always comes with risk. With growth investing, the risk is higher because these companies are new and untested. However, if they perform well, you could see significant returns in the near future. So, while there’s a calculated risk involved, the potential for high rewards makes it an attractive strategy.
How do you select stocks with growth potential?
To pick the potential growth stocks, check if the company ticks the following boxes:
1. The product solves a problem:
Top growth companies succeed by solving relevant problems for their target audiences. Take Google, for example. Before it came along, finding things on the internet was tough. You’d often end up with irrelevant or unwanted content. Google changed all that. It gave us a simple, single-field search engine prioritizing the most relevant results. Now, it’s something we all use and rely on daily.
2. What is the company’s TAM (Total Addressable Market)?
The total addressable market (TAM) is the overall revenue opportunity available for a product or service if it achieves 100% market share. The best way to analyze it is to consider how much consumers will spend annually on a product, service, or solution similar to the company’s. Most publicly traded companies share their TAM estimates in investor materials or IPO filings.
When checking this, ensure the TAM estimations are realistic. For instance, a start-up should refrain from claiming a global TAM since it could take decades to reach that market size. Instead, it is better to estimate the TAM based on the market the business can address within the next five years.
3. Scan the managerial efficiency:
When choosing stocks, it’s important to research the company’s management and assess its effectiveness. Quarterly managerial meeting pointers can give you insight into the company’s performance trends. Alternatively, the annual general meeting (AGM) pointers answer many questions and help gain further understanding. Apart from these, consider these pointers on management efficiency:
- Management Tenure: Longer tenure often signals stability and consistent growth.
- Shareholding Pattern: Quarterly reports disclose shareholdings by promoters, institutions, government, and retail investors. A higher promoter or institutional holdings suggest stronger company stability.
4. Check the revenue growth:
Top growth companies usually expand their top-line results much faster than the industry average. Take Tesla, for example. While vehicle manufacturers like General Motors saw sales drop from $140.2 billion in 2016 to $108.6 billion in 2020, Tesla’s revenue grew from $7 billion to $31.5 billion in the same period. Top-growth stocks often expand quickly because they disrupt the market with new products, processes, or by targeting unserved segments.
5. Check all growth margins:
Even though growth margins are initially narrow, high-growth stocks gradually expand their profit margins every year and usually have a high gross profit margin. This ensures that as business volumes grow, the company can turn higher sales into bigger profits. Focus on both revenue growth and operating margins. Revenue is the company’s total income while operating income is the gross profit shown in the income statement. A company with consistent revenue growth and strong margins is a good growth investment. For example, Bharat Rasayan has seen a 21.9% revenue growth over the past five years. Additionally, it has maintained an operating profit margin of 18-19%, indicating it’s profitable and manages expenses well.
6. Evaluate quantitative parameters:
There are several ways to evaluate a stock’s price and performance. A few of the parameters are:
- P/E Ratio:
The price-to-earnings ratio indicates how much an investor is ready to pay for Re.1 of earnings per share. Companies with high growth potential show a high price-to-earnings ratio, which means higher returns on investment. But sometimes, the high ratio is due to inflation-induced overvaluation. So you can adopt a thumb rule here – look for a P/E ratio of 1 or more; it is often a good sign for growth stocks.
- High ROE and ROCE:
Return on equity (ROE) measures profits from equity capital. Return on capital employed (ROCE) gauges how well a company uses its capital to increase profits. When picking growth stocks, focus on consistently growing ROE and ROCE over the last five years.
- Earnings per Share (EPS):
Look for steady growth over the last five years.
- Debt-to-equity ratio:
The Debt-to-Equity Ratio shows how much a company relies on debt versus shareholder equity. A lower ratio indicates better debt management and less financial risk.
- PEG Ratio:
You can use the price-earning-to-growth ratio to spot growth stocks from average ones. A high PEG ratio shows excellent business performance. Unlike the P/E ratio, the PEG ratio gives more reliable results.
Should I Adopt a Growth Investing Strategy?
Investing in high-growth stocks in India is for risk-takers looking for big investment returns. These stocks can multiply and offer significant capital gains, but with the following risks-
- Volatile prices that are influenced by market conditions and sentiment.
- Growth depends heavily on market conditions.
- Increased market competition may lead to market saturation and, thus, slow growth.
- Risk of overvaluation, where stock prices detach from the company’s fundamentals.
Growth stocks are ideal if you want long-term wealth rather than immediate income. That is because such companies usually don’t pay dividends but reinvest profits to fuel growth, appealing to those aiming for wealth through capital gains. So, if you’re ready to handle market ups and downs for potentially high rewards, adding growth stocks to your portfolio could be a savvy move.
Conclusion:
In conclusion, investing in growth stocks can really pay off if you aim to boost your returns over time. So, with proper research and a solid strategy made with the help of a SEBI-registered advisory, you can take advantage of the rising stock prices of these high-growth companies.
FAQs:
- Are value investing and growth investing strategies different?
Yes, both strategies differ. Value investors invest in stocks trading below their intrinsic value, while growth investors analyze the company’s future potential before investing.
- What are the common traps to avoid in growth investing?
- Serial acquirers: Companies that grow by acquiring others can be risky. First, because integrating new companies is tough, promised synergies may not pan out. And secondly, acquisitions usually happen at a premium, reducing the return on investment before profits are made.
- One-off growers: Some companies experience temporary growth due to external factors. However, such growth is hard to maintain later.
