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The Dos And Don’ts Of Growth Investing

Britain’s decision to leave the European Union came as a shock to many people. It even surprised those that were campaigning for Brexit.

So great was the disbelief that stock markets around the world buckled at the knees, briefly. But canny investors, namely, those who could see the woods for the trees, took advantage of the fall to add to their holdings.

Peter Lynch, one of the best growth investors of our time said: “Develop a disciplined approach to investing that enables us to block out our own distress signals”. The key to successful investing is to have a plan.

So whether you are a growth investor, income investor or a value investor, it is important to block out market noise, regardless of how loud the din might be.

With that in mind, here are some Dos and Don’ts of effective growth investing.

Don’t tune out just because you are not a growth investor. You should find a lot of things that apply to you, even if your preference is for dividend cheques or deep value, rather than capital growth.

Do look at cash flow. Cash is a company’s lifeblood. If it stops flowing, the company dies. A lot of investors focus on earnings, but earnings can be massaged. It might not accurately reflect the strength of a company’s operations. Cash flow, whilst not perfect, provides us with a better picture of a company’s health.

Don’t ignore the balance sheet. If we think of cash flow as a sphygmomanometer reading, then the balance sheet is the annual health report. A company with a strong balance sheet can cope with many of life’s surprises. Heavily-indebted companies, however, have much less flexibility.

Do look for innovation. While large companies have advantages of their strong brand names, robust balance sheets and industry leadership positions, they can also be too slow to respond to a changing competitive landscape. Small companies led by visionary management have the ability to quickly create new technologies and products.

Don’t rely on past performance. Few things in this world are guaranteed. So, a few years of 30% earnings growth are unlikely to be repeated, if only because it gets harder to grow as you get bigger.

Do control your emotions. We are our own worst enemies because of our tendency to make emotional decisions instead of using a rational process. Don’t get scared out of owning shares when they’re falling. That is often the best time to buy.

Don’t overpay. The fastest way to turn a phenomenal company into a terrible investment is to get swept up in the excitement of a rapidly-rising share price and pay more for the shares than the business could ever possibly be worth. Make a watch list of companies and sooner or later we are likely to get a great buying opportunity.

Do consider market size. It is easy to get sucked into a great growth story. A company’s growth potential is ultimately determined by the limiting size of its end market. So investors need to get a grasp of a company’s end market and how much room there is left to run.

Don’t forget to write down the reasons for buying shares. It can help us block out the noise of day-to-day market movements and keep an eye on the long term. It also makes selling decisions much easier. If a company isn’t living up to our expectations, it may be time to leave something for the next investor.

Time and again, investors will blame the market when things go badly wrong. But stock markets and companies don’t determine our fate. It is how we behave when the market tests our resolve that counts. With a clear investing plan in place, we should be much better prepared.

A version of this article first appeared in The Straits Times.

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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 Director David Kuo doesn’t own shares in any companies mentioned.