2 Quick Tips to Make You a Better Growth Investor

We all have our own little quirks and preferences. When it comes to investing, we can broadly pigeon-hole ourselves as an income, value, or growth investor. For me, the go-to strategy is to have growth on my side. While the patient value investor is content to wait for a catalyst for their value shares to appreciate, I prefer having an existing catalyst that can carry my growth shares forward.

The life of the growth investor

In the life of a growth investor, there are two useful ways to think about the future growth prospects of a company: Magnitude and probability. Magnitude refers to the potential size that a company is able to grow into. On the other hand, probability, as the term suggests, refers to the possibility of the company actually growing into its potential.

Take diamond systems manufacturer Sarine Technologies Ltd (SGX: U77) for instance. Sarine provides tools for different customers along the supply chain of diamond manufacturing. The latest innovation from the company would have to be its new products Sarine Loupe and Sarine Light.  These new products are targeted at the retail segment of the diamond industry.

According to Sarine, the market value of the retail segment (note: not addressable market) was estimated to be US$74.5 billion for 2013. Considering that Sarine’s revenue over the last 12 months stands at US$86.1 million, the two products – Sarine Loupe and Sarine Light – could provide a long runway for growth for the company. In other words, the magnitude of growth could be significant for Sarine.

Next up, we can consider the probability of Sarine growing into its potential. At its current state, Sarine mainly serves customers who process rough diamonds. Sarine has a much shorter track record when it comes to the retail segment of the diamond industry which deal with polished diamonds. The retail segment will also see Sarine having to deal with new types of customers and different market dynamics. So, despite its long track record in the upstream portion of the diamond industry, there is less certainty that Sarine will be successful in the downstream portion.

As such, the cautious investor may ascribe a fair to low probability of Sarine reaching its potential.

So when we put Sarine’s magnitude and probability together, the decision lies with the growth investor on just how much magnitude is needed to compensate for a low probability. Foolish investors should also note that decisions can be taken in stages. As my fellow Fool Sudhan noted, the results of Sarine Loupe would only be clearer in 2015 – investors can then think about Sarine’s magnitude and probability again after Sarine Loupe has been given some time to prove its worth.

In all, there are many other possible combinations between the two parameters of magnitude and probability. For instance, it is also possible to have a high probability (meaning to say a company has a strong track record of growth) with a low magnitude (a small addressable market size) – that’s a reverse from the situation Sarine’s in. The right mix is really then up to the individual investor to decide upon.

Foolish summary

The interesting thing here is that thoughts about a company’s future growth prospects need not be confined to growth investors alone. As Warren Buffett once said, value and growth are joined at the hip. When it comes to investing – whether it is value-based or growth-based – the valuation of the company would very often include a component of growth as well.

So, the next time you’re thinking about the growth part of the equation, consider using this simple framework to structure your thoughts around a company’s future growth prospects. It could just be an effective way to separate the best from the rest.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Chin Hui Leong doesn’t own shares in any companies mentioned.