Growth Investing Principles
When it comes to building wealth in the stock market, there are various ways and methods. You may already have tried different methods, but it seems that you are in a dead end. However, it is definitely possible to generate millions when trading stocks.
There are different types of investors, and everyone has its preferred investment option. For instance, income investors prize dividends the most, and value investors prefer buying stocks which trade under their initial value. Alternatively, growth investors focus on buying companies which have the best upside potential and aim to de-emphasize regular valuation metrics that commonly display a growth stock to be more expensive than the current earnings of the company. So, buying the proper firms during their early phase can generate huge fortunes for growth investors.
Growth investing can be great for generating high returns, but first of all, it is essential to understand what growth stocks are and if, given your specific circumstances, they are adequate investments. You can also use service like Motley Fool’s stock advisor to find these stocks. Day Trade Review provided an in-depth review of the premium stock picking service.
There is no miracle solution or method to guarantee returns with growth investing, especially when the company doesn’t meet the expectations. Yet, if you want to increase your chances of success further, you should definitely look for the following traits in your next potential company (or companies):
1. An Expanding Market Opportunity
For decades, the biggest growth stocks have increased their top line at a two-digit rate. Blue chip companies with the highest revenue on the market further increase their income by attacking enormous market opportunities.
There are various examples of successful growth businesses that are pursuing huge market opportunities. For instance, Tesla’s venture into the automotive industry and Amazon.com’s aim to disrupt the world from retail. Each one of these companies generates trillions of revenues in annual sales around the globe, which in return will further increase their success chances for future growth.
Besides, a key point of a company’s success is expanding its addressable market opportunity throughout the years. It can be achieved by implementing different services or products in new business segments as it has grown. Tesla and Amazon.com adopted this strategy, as well. Tesla was mainly founded to manufacture automotive products, but it has expanded its market opportunities throughout the years, and now it sells energy storage systems. As for Amazon.com, it began as a web retailer but now has a prosperous web services business.
“Optionality” is the company’s ability to enter nearby businesses, and it is a crucial factor that every growth investor should take into account when considering a potential growth investment.
2. Durable Competitive Advantage
One of the investment tenants of Warren Buffet is to purchase businesses with a strong competitive advantage, which he calls it the “moat” of a company. A company simply can preserve its competitive advantage over its competitors for an extended period, thereby protecting its profits from capitalism’s forces.
Also, there are four main types of competitive advantage:
- Intangible Assets: They are physical and measurable assets which are used in the operations of the company. These assets can be trade secrets, patents, and regulatory protection. Tiffany’s & Co is a great example. This company uses its brand name to convince the customers to pay more on its premium jewelry.
- High switching costs: If the switch to a competing product is expensive, customers tend to remain loyal to their current company even when there is a rise in the price. A great example of high switching costs is consumer banking.
- Low-cost producer: If a business enjoys scale, technological, or geographic advantage in which it can produce good product or service for a lower cost than its rivals, it can charge a lower price and still generate high revenues. Walmart is an excellent example of a low-cost producer; it has an efficient supply chain and enormous buying power to sell services and products with a much lower charge than its rivals.
- Network effect: If a new customer joins a network, an additional value is added for all the other members of the same network. For instance, the rise of social media can be linked to the network effect directly. The more users post media or links on a social media site, the more there is users’ appeal, and the more useful the platform is for the public.
When looking for your next big growth stocks, make sure to look for at least one of these competitive advantages. It will undoubtedly increase your chances of success and will yield great results and revenues.
3. Financial Resilience
When it comes to the economy, every company will face ups and downs throughout the years. Even blue chips can face hard times. That is why it is always better to favor growth companies that can fund the needs of their future growth with internally generated revenues rather than depending on functional financial markets.
Alternatively, it is recommended to avoid growth companies that are depending on a continuous stream of acquisitions or operating at a loss. When a company is operating at a loss, it will continuously have to tap shareholders for new capital to keep the doors open, which will certainly lead to high dilution level that will ultimately mute future revenues. The same situation goes for no-growth or slow business as well, which depend on acquisitions to post growth. The purchase of other companies directly can be expensive and often require the buyer to issue new shares or take debts to help with funding the deals.
These companies eventually rely on a factor beyond their control (a high stock price or functional capital markets) which may stop their growth if the economy sputters.
Pandora Media is an excellent example. Even though it has a fine brand name and has remarkably expanded its profits for many years, hundreds of millions of dollars are consistently lost annually. That’s what led the company to dilute shareholders with the offerings of secondary stock and tap the debt markets for new capital.
4. Business Model of Repeat Purchase
Attracting new customers to a company is difficult and costly. That’s why selling services or products to existing customers is far better for a business to make money instead of relying on a never-ending stream of new customers to increase its growth.
That’s why companies like Fitbit and GoPro were once top growth companies and now turned into losing investments. They both sell long-lasting electronic devices that negate the need to make a second purchase by the existing customers. As a result, these companies are in a constant need to drive more new customers to generate year-over-year growth. It was certainly possible before when they were small, but it is now getting more challenging with the expanding number of competitors and the saturation of the initial market niche.
Alternatively, an exceptional example of the repeat purchase business model is Starbucks. People don’t just jump from one coffee shop to another. If they like a place or a brand, they stick with it for life. Knowing that Starbucks already has a huge fanbase and a growing following, it’s easy to see why existing customers won’t be replacing it any time soon.
5. Strong Appreciation of Past Price
You should look for companies which have strong earnings growth during at least the past ten years. Besides, the minimum EPS growth depends on the company’s size. For instance, you may look for a growth of 5% or more for businesses that are larger than $4 billion, 7% or more for companies in $400 million-$4 billion, and 12% or more for the ones under $400 million.
The fundamental idea is that winning corportaions are likely to keep on winning. So, you should start looking for companies that have already beaten the stock market.
6. Excellent Business Culture
Due to the fierce competition between the different companies of the same industry, every business is regularly looking for highly talented employees to secure its valuable position on the stock market and satisfy the needs of its customers. This business culture is very crucial and a key factor for every company’s success.
You can look for a review of a company’s employees with a simple search on the internet. Having a look at the different reviews will provide you with a better understanding of any company’s culture.
7. Talented Leadership
The final, yet the most important principle you should look for in a company is a dedicated and talented CEO who is sincerely committed to the mission of the company and is highly motivated to turn the business into a success.
You should look for potential leaders in the different business that will not only provide a better future for the company but also increase your chance of generating high revenue with growth investing.
There are various leaders (whether they are founders or co-founders) who succeeded in turning a small business into a blue chip — for instance, Jeff Bezos at Amazon.com, Mark Zuckerberg at Facebook, and Reed Hastings at Netflix.
Furthermore, you can look for any potential leader on the internet, and you can have a better understanding about his/her current status in a particular company, education, work experiences, and major achievements. Also, look for videos where he/she gives does a presentation about the company’s service and product.
Additionally, check the company’s inside ownership rate to know if they own a lot of stock personally and aren’t working to earn a pay package.
Does the leadership team have a significant role in the company? Or are they selling the growth stock as soon it vests? You can find the answers in the SEC filings (look for recent Form 4s and DEF-14A).
Final Thoughts on Growth Investing
A successful strategy for growth investing is a long-term play. Make sure to follow the different principles listed above and opt for companies with products or services that you genuinely believe in and be ready to hold them through the up and down cycles of the market.