Growth Investing: Should You Adopt This Investing Strategy in 2022?
Ready for a new year, a new stock approach? Does growth investing make sense for your portfolio? Let's find out.
If investing was a Marvel character, growth investing might be like the Hulk, and value investing might be like Thor. You could debate the merits of each character all day and ultimately decide you'd like both to be at your disposal if you ever had to battle Thanos.
It's kind of the same between value investing and growth investing. The truth is, you probably want both in your back pocket.
Quick facts about growth stocks:
- They usually perform better when interest rates fall and company earnings go up.
- However, they may also dip when the economy isn't performing as well as it should.
Value stocks, on the other hand, tend to do well during an economic recovery but in a sustained bull market, they face downturns.
Let's walk through growth investing only and give you some steps you can take to implement growth investing in 2022.
What is Growth Investing?
Growth investing means you invest in companies in which revenues or cash flows will see higher earnings gains. Investors who invest in growth stocks hope that a company's upward growth will continue as companies continue to expand. Can you always guarantee a profit when you attempt to invest for growth?
No. In fact, growth stocks experience larger price swings, so heed the warning: You have to have a healthy risk appetite and many years on your side. You should also not buy growth stocks if you'll need the money you will invest within the next five years — you could lose it. Think you're the right type of investor to invest for growth? Here's how to make it happen.
Steps to Tackle Growth Investing in the New Year
Ready to prep for growth investing this year? Let's find out how to do it.
Step 1: Start identifying growth companies.
Why not jump straight to the fun part? Compare company growth with other companies in the same industry. Look for:
- Large, well-established businesses that continually garner positive earnings and increase their profit margins (both operating margin and gross margin). Look for above-average growth in earnings per share (EPS).
- Strong sales growth in companies that increase their revenues over time.
- Industries and companies you know well. You may already be an expert in the industry due to your professional background or expertise.
- High returns on equity relative to competitors.
- Low or manageable debt levels — check out a company's liabilities compared to competitors. Liabilities don't always have to be zero because a company might be investing in additional streams of income or other positive investments.
- High return on invested capital, which shows how efficiently a company spends its cash.
Ultimately, take a look at stocks that have a strong leadership team, large growth, target market, and strong sales. For example, you can study how these two growth stocks increase revenue and net income: Amazon (NASDAQ: AMZN) and PayPal (NASDAQ: PYPL).
Step 2: Look for red flags.
During your research, you want to look for red flags which might signal a poor investment choice or that raise your risk factors for loss. For example, look for:
- Recent annual net losses
- Recent CEO changes or other changes in higher management
- Falling sales
- Overvalued stocks — you may see a decline in shares as the stock price eventually reflects its true fundamentals.
Any impingement on growth can be a threat to your investment, so watch for these and other signals that company growth will become impaired.
Step 3: Consider large-, mid- or small-capitalization stocks.
Do you want to invest in large-cap, mid-cap, or small-cap stocks? Stocks of large-cap companies have the top 70% of the capitalization of the U.S. — in other words, they have a market capitalization of $10 billion or more. They tend to be less volatile because they are steady companies that will likely weather bumps in the economy. You can identify the best large-cap companies based on fast growth (high growth rates for earnings, sales, and cash flow) and high valuations (high price ratios and low dividend yields).
Mid-cap stocks have a market cap between $2 billion and $10 billion, and small-cap stocks have a market capitalization of between $300 million and $2 billion. It's worth noting that small-cap stocks have traditionally outperformed large-cap stocks but also carry more volatility and risk. Larger companies can threaten small-cap companies, so you might want to bypass small-caps altogether if you have lower risk tolerance.
The bottom line: Don't leave out mid-and small-cap stocks as you consider all your growth investing options.
Step 4: Consider buying a fund.
Sure, you can buy individual growth stocks, but a diversified fund might make more sense to make sure you get the most out of your time horizon and settle on the right risk tolerance. You can consider investing in index funds or mutual funds.
Whether you choose to invest in individual growth stocks or opt for growth funds, remember that value can go up or down for both and decline in bear markets.
Step 5: Invest and hold.
Next, set up an account and investigate the fees you'll pay. Buy the risk-appropriate amount of stock among the growth companies you've identified and hold onto your stocks for the long term. Give yourself 10 years or more to see your investments grow.
Consider Growth Stocks into 2022 and Beyond
Growth stocks put a shot of volatility into your portfolio, which is why you need to gear yourself up for a long-term investment strategy. Growth companies can stumble when they can't keep up with growth demands.
However, the gains can be unmatched. If you find stocks or funds that show tremendous upside potential compared to their competitors, you may find a winner on your hands. Growth stocks should outperform the overall market in time because of their vast upward potential. (As long as you've made the right picks, that is.)
One more thing to consider: Don't expect dividends, because most growth-oriented companies reinvest their earnings back into the company so they can — you got it — grow.
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