[SEO]Who Should Be a Growth Investor?

Stock market investors have several strategies that they can follow to make money.

Value investing has been popularized by Warren Buffett and it is the art of buying companies that are trading below their intrinsic value. Dividend investing is all about creating a predictable stream of income from the stock market. Growth investing is the act of buying companies that are rapidly increasing their revenue and profits in the hope to build wealth through capital appreciation.

Below, we'll dig into the details of growth investing to figure out if it's the right strategy for you.

Image source: Getty Images.

What is growth investing?

Growth investing is an investing strategy that is focused on building wealth through capital appreciation. Growth investors seek to buy businesses that are increasing their revenue and earnings at a much faster rate than the market in general and, importantly, will continue doing so for the foreseeable future.

Since most companies are valued based on a multiple of their profits the value of the entire business should rise along as the company's earnings grow. Generally speaking, the faster that a company's profits grow, the faster its stock price will appreciate and the more money its investors will make.

Many growth companies are able to increase their revenue of profits rapidly because they are commercializing a new product, service, or business model that is enabling them to take market share in an existing industry. In rare cases, the company is a pioneer in a brand-new industry. 

The benefits of growth investing

Most high-growth companies need capital to fund their expansion. That constant need for capital causes many of them to reinvest all of their profits -- if they have any -- back into the business. For that reason, most growth companies do not pay dividends to their investors. In addition, many high-growth companies trade at very high valuations, which can amp up their volatility.

Given these realities, why would anyone choose to invest in growth stocks at all? The primary reason is that a handful of growth stocks will go on to create a tremendous amount of wealth for their shareholders.

Here's a sampling of the returns that investors have earned in recent years by buying some of the greatest growth stocks on the market at their IPO:

Table source: Y-Charts. Yahoo! Finance.

Many of these growth stock multiplied their investor's money by 10, 50, or even 100+ times.

While identifying these companies early isn't easy, it only takes one or two of them to turn a small amount of money into life-changing wealth. 

Key principles of growth investing

Here's a look at some of the key characteristics that are shared by the greatest growth businesses of all time:

• History of rapid sales and earnings growth: Companies that sport a recent history of rapidly growing their revenue and profits are often able to continue doing so moving forward.
• A large and expanding market opportunity: The greatest growth stocks in history have consistently increased their top- and bottom-lines for many years. That's a tough act to pull off unless your addressable market opportunity is large and growing.
• A durable competitive advantage: Great growth companies usually enjoy a competitive advantage  that insulates their profits from rival businesses. Warren Buffett loving refers to this trait as a company's "moat." 
• Financial resilience: Hard times will fall upon every business at some point. Companies that maintain a fortress-like balance sheet that is pack with cash and light on debt will be able to weather any financial storm more easily than those that deploy a lot of leverage. 
• Strong past price appreciation: Wall Street tends to rewards growth companies that are executing well with a higher stock price. Conversely, it tends to punish those that companies that fail to deliver. Growth stocks that have already enjoyed a huge run tend to be the better bet for growth investors because it is an indication that the company has developed a winning formula for success.
• Great corporate culture: Growth businesses need to constantly attract and retain great people. The best growth stocks are usually highly regarded as a great place to work. 
• Leadership with skin in the game: Growth investors should favor companies whose management teams have a great deal of their own net worth invested in the success of the business

Famous growth investors

Many of the most well-known investors of all time are value investors ( say hi Warren Buffett, Benjamin Graham, and Seth Klarman).

However, there are a handful of well-known growth investors, too:

Peter Lynch

Lynch managed Fidelity's Magellan Fund for more than 13 years. During his tenure, his investors earn an average annual return of 29%, which crushed the S&P 500. Lynch's assets under management swelled from just $20 million at the start to over $14 billion when he stepped down.

Lynch popularized the idea of "buying what you know", which means to look for a business with products or services that you have used yourself. Lynch has generously shared his investing principles in the three books that he authored One Up On Wall Street, Beating The Street, and Learn To Earn. 

He is also a big believer in keeping investing as simple as possible and famously stated: "Never invest in any idea you can’t illustrate with a crayon."

William O'Neil:

O'Neil is a growth investor that was a pioneer in the use of computers to help make investing decision. He typically looks for companies that are growing their earnings at a rate of at least 25% annually and also have a track record of beating the market. 

O'Neil detailed investing a well-known investing checklist that he calls the CAN SLIM method to find great growth stocks. O'Neil started to share his investment research with others in 1984 when he launched Investor’s Daily, which was later renamed Investor’s Business Daily. O'Neil is a strong believer in using both quantitative and qualitative strategies to pick stocks. 

O'Neil has outlined his CAN SLIM investing philosophy in detail in his three books How To Make Money In Stocks, 24 Essential Lessons For Investment Success, and The Successful Investor.

Thomas Rowe Price, Jr.

Price is considered by some to be the “father of growth investing.” Price decided to go on a buying spree in the middle of the Great Depression because he felt that financial markets operated in cycles and that it was a great time to buy strong companies to hold for the long term. Price favored businesses that he felt could grow their earnings and dividends at a faster rate than the general economy. 

Price founded T. Rowe Price Group (NASDQ:TROW) in 1937 which has since grown to become a publically trade multinational investment firm.

Philip Fisher

Fisher is another investor that is widely viewed as one of the early adopters of growth investing. Fisher started an investment firm called Fisher & Company in the middle of the Great Depression and he ran it until he retired in 1999 at the age of 91.

Fisher created a fifteen point checklist of characteristics that he looked for in common stocks. He was also one of the first investors to emphasize the importance of having a high-quality management team in place, which was a rarity in his tie. 

Fisher outlined his growth investing philosophy in his 1958 book "Common Stocks and Uncommon Profits." This book is still one of the most popular books on growth investing today and even famed value investor Warren Buffett considers it to be a must-read. Fisher also authored two other books on growth investing called Conservative Investors Sleep Well and Developing An Investment Philosophy. 

Growth investing today

Growth-stock investing has performed very well in the decade following the Great Recession. A huge portion of the gains has been driven by the success of the "FANG" group of tech stocks -- which stands for Facebook, Amazon, Netflix, and Google (Alphabet).

These four businesses have played a role in helping growth stocks to vastly outperformed value stocks over the past decade

IWF Total Return Price data by YCharts

In times like this, it is natural for growth investors to start to get nervous. Markets tend to move in cycles, so the next decade might shine upon value stocks instead of growth stocks. 

However, even if growth stocks as a group underperform value stocks, there will still be plenty of individual growth stocks that perform exceedingly well. 

For example, here's a sample of a few well-known growth stocks that analysts believe have will experience huge profit growth over the next half-decade:

SOURCE: FINVIZ. 

While it is unknown whether or not these businesses will be able to deliver against their lofty expectations, they have each grown their earnings by more than 30% annually over the past five years. That's a great sign for investors who like to bet on companies with a recent track record of success.

Is growth investing right for you?

Here are a few questions that you can ask yourself to find out if you should become a value investor, dividend investor, or growth investor:

How long is your time horizon? 

Even the greatest growth stocks in history are mauled from time to time. 

Take a look at some of the more famous peak-to-trough drops in recent years:

• Facebook fell 50% soon after its IPO in 2012.
• Mastercard dropped 60% between 2008 and 2009.
• Apple declined more than 75% on the 1980s, 1990s, and early 2000s.
• Tesla fell 50% between 2014 and early 2016.

While all of these companies eventually recovered from their monstrous declines it often took a year or more for that to happen.

Since huge declines can happen at any time, growth investors need to own their stocks with a multi-year time horizon. Any time period shorter than that runs the risk that the investors will sell during an inopportune time. 

What's your appetitive for risk and volatility? 

It's worth stating again: even the greatest growth stocks of all time experience huge price drops from time to time. Heck, even extremely stable companies like Proctor & Gamble, Hershey's, and Johnson & Johnson experience double-digit drawdowns every now and then. Growth investors must be able to endure these kinds of sudden drops if they wish to be successful. Otherwise, they're better off with safe but low-return investments like bonds or CDs.

Are you looking for income?

The majority of growth businesses retain all of their capital in order to fund growth projects. As a result, most do not pay a dividend. If you're the type of investors that wants or needs to generate income from your portfolio then value investing and dividend investing are probably better choices for you. 

How much time do you want to spend managing your investments?

Building a portfolio of growth stocks takes time. Investors have to be willing to regularly scan the markets for stocks that fit their criteria and keep regular tabs on the stocks that they already own. Investors who are unwilling to do so are probably served by putting their capital into an index fund and calling it a day. 

Are your personal finances in order?

Growth investors need to be able to be patient for extended periods of time. That's why it makes a great deal of sense to make sure that your personal finances are in tip-top shape before you think about buying growth stocks. Building an emergency fund, paying off your debts, and fully funding your retirement accounts are smart moves to make before you think about buying a growth stock.

Investing greats such as Peter Lynch and Philip Fisher showed that growth-stock investing can be a winning strategy for investors to follow when they choose wisely and commit to holding for the long term. While it's not easy to be a great growth investor, when done correctly, it's clearly a valid investment strategy.