The Motley Fool

What You Need To Know About Growth Investing

There are a few different investing styles that investors can adopt, and each has its own advantages and disadvantages. However, the most important thing for us to do as an investor is to pick one that we feel most comfortable with. That’s how we can sleep soundly at night.

The few investing styles I am referring to are: income investing, growth investing, and value investing. In this article, I will be focusing on growth investing.

Growth stocks – what growth investors look for – are typically the riskiest. Growth stocks are perceived to have a long runway for growth in their businesses, and they don’t come cheap when analyzed by traditional metrics.

They tend to have high price to earnings (P/E) ratios and low dividend yields, but growth investors believe that these companies will be able to grow their businesses rapidly over time. The idea is that a growth stock’s high rate of future business growth makes it seem cheaper than it appears right now. It’s also worthwhile noting that many growth stocks have a nonexistent P/E ratio – this is because they are still loss-making, or reinvesting their earnings back into the business.

For companies without earnings, the price to sales (P/S) ratio can be used as a valuation metric instead. It is calculated by dividing the price of a stock by its revenue per share. There are many examples of high-growth technology companies that have negative or minimal earnings, as they prefer to reinvest heavily into their business to drive growth. This makes it rather necessary for growth investors to have patience as there is delayed gratification involved.

Another metric that could be used for valuing growth stocks is the forward P/E ratio. The forward P/E ratio is calculated by dividing a stock’s price by an estimate of its earnings per share over the next 12 months. Another metric that could be used is the P/EG ratio, which is known as the price/earnings-to-growth ratio. It is derived by taking the P/E ratio of a stock, and dividing it by the expected earnings growth rate of the company – in general, the lower the PEG ratio is, the better it is.

One of the risks that growth investors need to be aware of is over-optimism about a company’s growth prospects. What this means is that estimates of a company’s future earnings may be too aggressive, and if those aggressive estimates are used, investors will end up overpaying for the stock.

Having looked at what the growth investing style entails, investors should keep in mind that an investing style should be chosen based on individual preferences. This is important to ensure that an investor can stay invested for the long term without falling prey to emotional mistakes.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice.