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Guide to Growth Investing – Basics, Investment strategies and Earnings

A type of investment strategy centred on capital growth is called growth investing. Those who invest in businesses showing evidence of above-average growth are known as growth investors. Let us understand Growth Investing in detail.

Investors follow various investing strategies. Some of these include value investing, growth investing, dividend investing, etc. Value investing involves investing in companies that are trading at valuations below their intrinsic value. Growth investing involves investing in companies with a high growth rate in sales, profits, etc. Dividend investing involves investing in companies that regularly distribute most of their profits to shareholders. This article will focus on growth investing – basics, investment strategies and earnings.

What is growth investing?

The process of growth investing involves identifying and investing in companies that are currently in a high growth phase. The high growth can be in revenues, profits, etc., along with high margins, return on equity, etc. High-growth companies usually trade at higher valuations than other companies due to their superior growth.

Most high-growth companies constantly invest their profits back into the business to expand it. As a result, they either don't declare dividends or declare very small dividends. High-growth companies trade at high valuations. As a result, these companies are usually the first to fall whenever the overall market falls. Also, when the overall market falls, high-growth companies usually experience the maximum fall because of their high valuations.

Investing in growth sectors

In India, sectors such as Information Technology (IT), infrastructure, healthcare, financials, new-age companies, etc., are witnessing high growth rates. The IT sector has exhibited good growth since the start of the millennium. To date, IT companies are showing good growth rates, although the growth rate has slowed earlier.

Sectors like infrastructure and healthcare are doing well as the demand is high and the existing capacity is low. India is a developing country, and the infrastructure such as roads, railways, airports, and sea ports are being developed at a rapid scale. In healthcare, the number of hospitals, doctors, caregivers, and diagnostics centres is way too less to meet the needs of the huge population.

The new-age companies such as Nykaa, Paytm, Policybazaar, etc., have recently been listed on the stock exchanges. These companies are disrupting the respective sectors in which they are operating and experiencing high growth rates. Many other start-ups plan to come up with their Initial Public Offering (IPO).

All the above sectors and the companies operating in these sectors provide a good opportunity for growth investing.

Understanding earnings

Growth investing involves identifying companies with high growth potential in their earnings. The investor should evaluate the past earnings of the company and also have the ability to project the future earnings of the company. If the company is expected to continue reporting high growth in earnings as in the past or even better the growth rate, it will be a good candidate for growth investing. 

If the company is currently reporting losses or low profits but is expected to report high profits in future, then also it will be a good candidate for growth investing. The investor should also evaluate whether the growth in earnings is accompanied by an improvement in profit margins.

Using the price-to-earnings (PE) ratio for evaluating growth companies

  • The PE ratio is used to compare companies operating in the same industry. The PE ratio is the ratio of the company's share price in relation to its earnings per share (EPS). For example, Apollo Hospitals' share price is Rs. 3,600, and the company is expected to post an EPS of Rs. 100 for the current year. The Apollo Hospitals' share is trading at a PE of 36.
  • A growth investor will compare the PE ratio of Apollo Hospitals with the PE ratio of other listed healthcare companies, such as Fortis Healthcare, Narayana Hrudayalaya, etc., to evaluate whether Apollo Hospitals is better than these companies for investment.

Using price-to-book (PB) ratio for evaluating growth companies

  • The PB ratio can be used to compare the listed company's share price with its book value. The PB ratio is a good yardstick to compare financial companies such as banks and NBFCs for growth investing purposes.
  • For example, a growth investor wants to compare banks like HDFC Bank, Kotak Bank, ICICI Bank, etc., for investment purposes. In this case, the investor can compare the PB ratio of these banks and take an investment call.

Growth investing through value investing

An investor can also combine growth investing with value investing. For example, a small company with high growth prospects but not yet discovered by the broader market may be trading at low valuations. In this case, as the company is trading below its intrinsic valuation, it qualifies for value investing. At the same time, the company has high growth prospects; hence, it qualifies for growth investing.

Similarly, there may be small companies from the sunrise sectors. These companies have growth prospects. But, since they are from the sunrise sector, the market may not have discovered them and hence trade at low valuations. Hence, these companies qualify for value investing as well as growth investing.

High-risk growth investments

Apart from direct equity and equity mutual funds, high-risk growth investments can include other asset classes also. Some of these include equity derivatives (futures and options), commodities, currencies, non-fungible tokens (NFTs), cryptocurrencies, art and other collectables, etc. Many of these high-growth investments are speculative in nature and involve high risk. There is a high risk of incurring losses in these investments, including the entire capital getting wiped out. So, the investor should allocate a very small portion of their overall investment portfolio to these high-risk growth investments.

Asset allocation is the key

An investor should follow appropriate asset allocation and have a well-diversified investment portfolio with an allocation to equity, fixed income, gold, real estate, etc. Within equities, the investor should distribute the money among core and satellite portfolios. From the core portfolio, mid-cap and small-cap mutual funds can be a part of growth investing. From the satellite portfolio, sectoral and thematic mutual funds can be a part of growth investing.
To start investing in mutual fund schemes as per your appropriate asset allocation, download the Glide Invest App from Google Play Store or Apple App Store and get started.

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