Last Updated on October 10, 2022 by Oddmund Groette
When it comes to investing, there are many strategies you can adopt. And if you want to make your money work harder, it’s important to choose the right investment approach. Intro 750
A growth stock trading strategy is a method of stock investing that focuses on companies that are expected to grow at an above-average rate compared to their industry or the broader market. While the growth stock trading strategy has the potential for high returns, it can be very risky. Careful research and analysis of companies’ fundamentals is important.
In this post, we take a look at growth stock trading strategy and we end it by doing a few backtests of the strategy.
What is a growth stock?
A growth stock is a publicly traded company that is expected to grow at a faster rate than the average growth for the market. Such stocks often tend to pursue growth by reinvesting their earnings into research and development or expansion into other regions and markets. As such, they do not often pay dividends until after they have attained a certain milestone.
Growth stocks are mostly small-cap stocks from new companies, but some larger companies may also be growth stocks if they are innovative and continually expanding into new areas of business that drive growth — examples of such big companies include Amazon, Microsoft, and Apple. When investing in growth stocks, the expectation is to earn money through capital appreciation when the stocks are stocks in the future.
Growth stocks tend to share a few common traits, such as the following:
- They tend to have low earnings or may not have earnings at all at the present as they are investing in growth
- They tend to have a high price-to-earnings (P/E) ratio
- They tend to have unique product lines and may hold patents or have access to technologies that put them ahead of others in their industry.
- In order to stay ahead of competitors, they reinvest profits to develop even newer technologies and patents as a way to ensure longer-term growth.
What is a growth stock strategy?
A growth stock trading strategy is a method of stock investing that focuses on companies that are expected to grow at an above-average rate compared to their industry or the broader market. It is the idea of buying only fast-growing companies that retain their earnings to pursue growth, in hopes of outsized returns in the future·
Growth investors tend to favor smaller, younger companies poised to expand and increase profitability potential in the future. Those are often new companies in emerging markets and innovative industries, like high-tech. While growth stocks have the potential for high returns, they can be risky. Thus, it is important to make careful research and study the company’s fundamentals and ability to stay competitive.
A growth stock example
An example of a growth stock would be a company that develops new technology and is the first to provide a new service. Such a company would gain a lot of market share very fast for being the only company providing a new service. If other companies later enter the market with their own versions of the service, they may struggle to take market share from the first company. If this company manages to attract and hold the largest number of users for that service and keeps innovating to stay competitive, it would be considered a growth stock.
For example, Amazon in the early 2000s was a new growth stock with the potential for huge returns. It delivered massive returns in the long run. A $1000 investment in 2001 would have yielded over a million dollars by 2021. Even up to this moment, Amazon is still considered a growth stock because of the way it innovates and expands into other business areas.
Similarly, Tesla in 2012 is another mighty growth stock. Despite the growth over the years, Tesla still has a lot of room for growth, so it is still a growth stock.
Growth investing vs. value investing (evidence)
There are many ways growth investing differs from value investing. These are some of them:
- Earnings: In growth investing, investors are interested in a company’s potential for growth and may not bother much about the current earnings, as long as the company’s business model can make profits in the future. Value investing, on the other hand, seeks to buy stocks at a discount so it aims to capture stocks with good earnings that are wrongly underpriced (undervalued).
- P/E ratios: Growth investors don’t bother much about high P/E ratios, as they focus mainly on a stock’s ability to appreciate significantly due to strong growth in the underlying company. Value investors, on the other hand, use the P/E ratio to assess how expensive a stock is and whether it is overpriced or underpriced.
- Dividends: growth investors are not usually interested in dividends, but value investors might consider it when choosing a stock to invest in.
Growth investing pros and cons
Some of the merits of growth investing include the following:
- There is a chance for massive returns if you pick the right stocks
- It’s a good way to support start-up companies
Despite the advantages, growth investing has its demerits, which include:
- The investment risk is high, as not all growth stocks would end up competitive
- There is no dividend income
Growth stock trading strategy backtest
A backtest of a growth stock trading strategy is coming soon