When it comes to investing your money, you have plenty of options. Whether you’re investing a portion of your income to save for your retirement or to pay for a child’s education, it’s important to understand the various strategies that are available to you before you decide when and how to invest.
At Addition Financial, we often discuss investment strategies, such as a growth investing strategy, with our members. A specific approach that comes up is a growth investing strategy. To help you choose the right investments for your needs and financial goals, here’s what you need to know about a growth investment strategy and seven pros and cons to consider before you invest.
What is growth investing?
This investment style focuses on buying stock from new and emerging companies with significant growth potential. These companies are often on the small side and may not have a long history of earnings to provide estimations of future growth.
The benefit of investing in newer companies is that if they succeed, they may increase their earnings at a rate that outpaces the market, making it possible that stocks purchased early will experience an enormous increase in value over time.
It may be useful to contrast growth investing with value investing, which takes the opposite approach. With value investing, investors look for companies with a long history of growth whose stock is trading at an amount they feel is too low. In other words, they buy stocks that they feel the market is undervaluing.
The other key difference between growth investing and value investing is that growth investing is the riskier option of the two. Since most of the companies you’ll invest in with a growth strategy are smaller and have a shorter history than other companies, there is a risk that a company will not meet strong growth projections and may even fail.
5 factors in growth investing
There are five key factors that growth investors look for when choosing a value stock to buy:
- The company’s historical earnings
- The company’s potential future earnings
- The company’s profit margins
- The return on equity (ROE)
- Share price performance
If you decide to adopt a growth investing strategy, it’s essential to research each company you invest in, both to maximize the growth potential of your investments and to mitigate your risk.
What are examples of growth investing?
There are several investment categories that may fall under the umbrella of growth investing. You may want to consider any or all of these as you build a growth investment portfolio.
Small-cap stocks
The term ‘cap’ refers to the market capitalization or net worth of a stock, and stocks are typically divided into micro, small, mid, and large-cap categories. Small-cap stocks are stocks in companies that have between $300 million and $2 billion in market capitalization.
Small-cap stocks have greater growth potential than large-cap or blue chip stocks, but they also come with greater risk. Historically, small-cap stocks have outperformed stocks from large companies after a recession.
Healthcare & technology stocks
Healthcare and technology stocks fit nicely into a growth investment strategy because both industries have the potential to introduce revolutionary products that give them high growth potential.
One of the most impressive examples of growth potential is Apple. When Apple stock first became available to the public, it was selling for an average of $0.0845 per share. In 2022, Apple stock sold for an average price of $154.15 per share.
Dividend growth investing
You can earn some money in the short term with growth investing if you choose dividend stocks from companies with growth potential.
Dividends are payments made to shareholders, often on a quarterly basis. Your earnings may be low at first but each time you collect a dividend payment, you’ll be earning income on your investment. You may choose to reinvest your dividends or cash them out.
Speculative investments
The growth investing category with the highest risk is speculative investments. Here are some examples of specific investments that fall into this category:
- Penny stocks
- Futures
- Options contracts
- Foreign currency
- Speculative real estate/undeveloped land
- Oil and gas drilling partnerships
- Private equity
The thing to be aware of before undertaking any speculative investment is the high degree of risk. Most of the people who engage in speculative stock investing are high-income people who can afford to lose everything they invest.
7 pros and cons of growth investing
Now, let’s review seven pros and cons of choosing a growth investing strategy.
Pros of growth investing
Here are some of the advantages of choosing a growth investing strategy.
#1: High returns
The first advantage of growth investing is that you’ll have the chance of earning an extremely high return on your investment. We already talked about Apple as an example of an investment that has earned high returns over time. Other tech companies have had similar success, including Amazon and IBM.
A small investment now could lead to big earnings later if you hold your stock and you’re willing to ride out market fluctuations. It’s important to note that growth investments should be viewed as a long-term investment strategy.
#2: Growth potential
Growth potential and earnings go hand in hand. When compared to value investments, growth investments have far more room to grow. When blue chip investments usually return a small but reliable return on investment, growth stocks have the potential to do far more.
Anybody who doesn’t mind taking a bit of a risk can benefit from the long-term potential of growth investments.
#3: Invest in new/growing companies
If you’re someone who enjoys the idea of supporting new and growing companies, then using a growth investment strategy may be right for you.
You’ll need to do some research to be sure you understand each investment before you make it, but growth investing makes it possible to support companies whose products and/or mission you believe in while providing the opportunity to grow your investment at the same time.
#4: You can get stock at bargain prices
Finally, you can buy growth stocks at prices that are often far lower than what you would expect to pay for high-cap or blue chip stocks, meaning that you’ll own a bigger stake in the companies you invest in.
As you might expect, owning more shares also leads to greater earning potential, so that’s something to keep in mind as you choose your investments.
Cons of growth investing
Now, let’s look at the cons of growth investing, which are important to consider before you put any of your earnings into these investments.
#5: Growth investing comes with high risk
Arguably the biggest downside of growth investing is that it carries with it a significantly higher risk than value investing. With value investing, you can rely on a stock’s history to help you understand how much of a return you’ll get on your investment. That may not be the case with growth investing.
A small-cap company or a company in a high-growth sector such as healthcare or technology may have the potential for high or even exponential growth. However, there’s no guarantee that the investments you choose will experience significant growth. They may come with far slower growth than you anticipated or no growth at all, and either way, you’ll need to be prepared for that.
#6: You may not earn anything
There is a wide range of growth investments to choose from, but all of them carry some degree of risk. There’s a risk that you may not earn anything on your investments and almost certainly won’t earn much in the short term.
You’ll need to keep the long-term prospects of any growth investment you choose. Remember, you’ll be investing in the potential of a company, not its current value. People are most likely to lose money when they pull out of their investments too quickly.
#7: You could lose your investment
The biggest of all the risks associated with growth investing is that you might lose your entire investment if a company fails. That’s why most speculative investments are reserved for high-income investors who can afford to take a hit.
It’s for this reason that we recommend choosing growth investments wisely and balancing them with other investments to make sure you’re not taking more risk than you can bear.
Tips for growth investing
Here are a few tips to keep in mind if you decide you want to pursue a growth investment strategy:
- Research your investments. We can’t overstate the importance of looking at a company’s stock and earnings history before you invest. While research won’t eliminate your risk, it will help you choose between acceptable risks and unacceptable ones.
- Honor your tolerance for risk. Some people are more comfortable taking risks than others. As you ponder your investment strategy, make sure to consider how much risk you want to take and how much you’re prepared to lose before you buy any stock.
- Diversify your investments. Risk diversification is a must in any portfolio. As a rule, you shouldn’t have more than 10% of your portfolio in any one investment. You should also balance high-risk, medium-risk and low-risk investments as a way of avoiding large losses that could decimate your earnings.
- Take a long-term approach. Finally, take a long-term view of investments in the stock market. Remember that the overall trend of the stock market is up and when big corrections occur, you’re likely to be better off if you hold onto your stocks rather than selling them at a loss.
Using these tips, you can begin to build a stock portfolio that uses a growth investing strategy to maximize your earnings.
Build your growth investing portfolio
Growth investing is a good long-term strategy if you want to maximize your earnings and you don’t mind taking some risks with your investments. The seven pros and cons we’ve listed here can help you decide whether growth investing is right for you.
Do you need some advice about building your investment portfolio? Addition Financial is here to help! Click here to learn about our Financial Services and book an appointment with one of our Financial Professionals from LPL Financial.
Posted on Jun 16, 2023
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