Growth investing

Definition

Growth investing is an investment strategy that focuses on buying stocks of companies expected to grow at an above-average rate compared to their industry or the overall market. Investors who adopt this strategy seek out companies that exhibit signs of potential for substantial growth, often prioritizing future earnings and revenue increases over current valuation metrics.

5 Must Know Facts For Your Next Test

1. Growth investors typically look for companies in emerging sectors like technology, healthcare, and consumer discretionary, where the potential for rapid expansion exists.
2. This investment style often involves higher valuations based on metrics like price-to-earnings ratios (P/E), as investors are willing to pay more for expected future growth.
3. Growth investing may involve higher risk due to reliance on future performance, which can be affected by market volatility and changes in economic conditions.
4. Many growth stocks do not pay dividends, as companies often reinvest profits back into the business for expansion and development.
5. The performance of growth stocks can be sensitive to interest rates; rising rates may lead to lower valuations as future earnings become less attractive.

Review Questions

• How does growth investing differ from value investing in terms of investment strategy and company selection?
  • Growth investing focuses on selecting stocks from companies expected to grow rapidly in terms of earnings and revenue, often regardless of their current valuation. In contrast, value investing seeks out undervalued companies with strong fundamentals that are trading below their intrinsic value. While growth investors prioritize future potential and high-growth industries, value investors emphasize financial stability and market correction opportunities.
• Discuss the risks associated with growth investing and how these risks can impact investor decisions.
  • Growth investing carries several risks, including market volatility, which can lead to significant price fluctuations in growth stocks. The reliance on future earnings projections makes these investments sensitive to economic changes and interest rate shifts. Additionally, if a company's anticipated growth fails to materialize, its stock price can decline sharply. Investors must weigh these risks against potential rewards when considering growth investment opportunities.
• Evaluate how macroeconomic factors like interest rates and inflation can influence the performance of growth investing strategies over time.
  • Macroeconomic factors such as interest rates and inflation play a critical role in shaping the performance of growth investing strategies. When interest rates rise, the present value of future earnings decreases, making high-growth stocks less attractive compared to dividend-paying investments. Similarly, high inflation can erode purchasing power and dampen consumer spending, impacting the revenue growth of companies. Therefore, growth investors must continuously assess how these economic indicators might affect their investment choices and adjust their strategies accordingly.

Related terms

Value Investing:

Value investing is a strategy where investors seek stocks that appear undervalued based on fundamental analysis, aiming to buy them at a price lower than their intrinsic value.

Market Capitalization: Market capitalization refers to the total market value of a company's outstanding shares of stock, often used to categorize companies as large-cap, mid-cap, or small-cap.

Earnings Growth Rate: The earnings growth rate measures the annual rate at which a company's earnings are expected to grow, serving as a key metric for growth investors in assessing potential investments.