Introduction
Growth investing is a strategy that focuses on companies expected to increase revenue, earnings, cash flow, or other important business measures faster than average. Investors accept that these companies may trade at relatively high valuations because they expect future growth to justify the price.
Successful growth investing depends on more than finding a company with rapidly rising sales. Investors also need to consider profitability, competitive advantages, market opportunity, financial strength, and the price paid for the stock.
Because expectations can become very high, growth stocks can experience sharp declines when business results disappoint or market valuations fall.
What is growth investing?
A growth investor looks for businesses that may become substantially larger or more profitable in the future. These companies often reinvest cash into expansion, research, new products, marketing, acquisitions, or additional capacity.
As a result, some growth companies pay little or no dividend. Investors may instead expect most of their return to come from a higher share price if the business successfully expands.
Growth investing is commonly associated with technology companies, but growth businesses can exist in healthcare, consumer products, financial services, industrials, and many other industries.
What growth investors look for
Revenue growth
Strong sales growth can show that demand for a company’s products or services is expanding. Investors also look at whether that growth appears sustainable.
Earnings and cash flow
Revenue growth is more valuable when it can eventually produce profits and cash flow. A company that grows sales while continually losing money may require additional financing.
Market opportunity
A large or expanding market can give a successful company room to grow for many years. However, attractive markets also tend to attract competitors.
Competitive advantage
Brands, network effects, technology, switching costs, scale, or other advantages may help a company defend its growth and profitability.
Growth and valuation
A strong company is not automatically a good investment at every price. Growth stocks often trade at higher valuation multiples because investors expect future earnings to expand.
Common measures include the price-to-earnings ratio, price-to-sales ratio, and ratios based on cash flow. The appropriate measure depends on the business and whether it is currently profitable.
If investors pay a very high price based on optimistic assumptions, even strong growth may not be enough to produce attractive returns. The stock can fall if future results merely fail to exceed expectations.
Growth investing versus value investing
| Characteristic | Growth investing | Value investing |
|---|---|---|
| Primary focus | Future business expansion | Price relative to estimated underlying value |
| Typical valuation | Often above market averages | Often below market averages |
| Dividends | May be low or absent | Can be more common, but not required |
| Key risk | Growth or expectations disappoint | Low valuation reflects lasting business problems |
The distinction is not always clear. A fast-growing company can become a value investment after a large price decline, while a traditionally inexpensive company can also have meaningful growth prospects.
Our guide to value investing explains the other side of this comparison in more detail.
Why interest rates can matter for growth stocks
Stock values reflect expectations about future cash flows. Many growth companies are valued heavily on profits expected years into the future.
When interest rates and required returns rise, distant future cash flows can become less valuable in today’s terms. This can put pressure on high valuations even when the underlying company continues growing.
Interest rates are not the only driver, however. Business performance, competitive position, market sentiment, and the starting valuation also matter.
Potential benefits of growth investing
A company that compounds revenue and profits at high rates for many years can create substantial shareholder value. Successful growth investors aim to identify these businesses before their future potential is fully reflected in the stock price.
Growth investing can also provide exposure to new technologies, changing consumer behavior, and expanding industries. Some of the world’s largest companies reached their size through long periods of business growth.
Still, identifying future winners in advance is difficult. Strong industries can produce both successful companies and many failed competitors.
Risks of growth investing
High expectations are a major risk. When a stock already assumes rapid future growth, even a modest slowdown can lead investors to reduce the valuation they are willing to pay.
Young growth companies may also have limited profits, high spending needs, or dependence on external financing. Competition can reduce margins, while technology or customer preferences can change quickly.
Finally, growth stocks can become concentrated in particular sectors or themes. Diversification remains important even when several companies appear to have attractive growth prospects.
How investors can use a growth strategy
Investors can research individual growth stocks or use mutual funds and ETFs that follow growth-oriented strategies. Funds can spread company-specific risk across a larger group of holdings.
However, a growth label does not mean every fund follows the same rules. Investors should examine the underlying index or selection method, sector concentration, valuations, costs, and largest holdings.
Growth investing is one of several core investing strategies. Its suitability depends on the investor’s goals, risk tolerance, time horizon, and broader portfolio.
Key takeaways
- Growth investing focuses on companies expected to expand revenue, earnings, cash flow, or other business measures faster than average.
- Growth investors often examine market opportunity, competitive advantages, profitability, and reinvestment opportunities.
- A strong business can still be a poor investment if the stock price assumes unrealistic future growth.
- Growth stocks can be sensitive to changes in expectations, valuations, and interest rates.
- Growth and value investing are different approaches, but the categories can overlap.
- Investors can pursue growth through individual stocks or diversified funds.