Stock Market Analysis: Growth Investing is a strategy that seeks to invest in companies with very strong and above average future growth potential.
It could be contrasted with the more conservative income investing strategy which seeks a fairly predictable and steady return from solid companies. Growth investors, on the other hand are looking for dramatic growth on the capital investment itself. Often these companies will emerge from new industry sectors or are pioneers who develop the initial product. An early investor in Microsoft in 1986 would have made many thousands of per cent on their initial investment in 20 years. Although most are never lucky enough to realise that kind of profit, growth investors seek stocks that have the potential to at least double in price in five years. The profit comes from growth in the price of the stock rather than dividends.
Investors would not expect to see steady income from a growth company. Generally a company at this stage does not have access to large capital reserves. Profits will be reinvested back into areas like research and development, growing market share etc.
Although growth investing is more high risk there are guidelines used to conduct this type stock market analysis. Their performance will also be compared to past performance and competitors in their field. Rapid growth should be reflected in expanding sales and earnings on an annual basis.
Earnings Per Share should be growing over the last 5 or 10 years. Earnings per Share (EPS) measures how much of a company’s earnings net of taxes and preferred stock dividends is allocated to each common share. To calculate EPS divide the net income by the number of shares outstanding. For example, a company earns $2,000,000 in the fourth quarter. There are 10,000,000 shares outstanding so EPS = 20 cent. Earnings per share are typically announced on a quarterly basis.
Analysts look for growth rates that could be as high as 15% per year for the next five years. Investors will also assess whether the management are controlling costs. Profit margins need to be maintained. Profit Margin measures the number of dollars of after-tax profit a firm generates per euro or dollar of sales. A company that makes 10c for every $1.00 of sales revenue has a 10% profit margin. It is possible for a company to have rapidly growing sales that is not matched in the earnings figures because of decreasing profit margins.
Investors also look for a healthy Return on Common Equity (ROCE) which reflects the efficiency of the use of the company’s assets. Return on Common Equity (ROCE) measures the profitability of a company relative to the capital employed. Capital employed is the total of shareholders equity and long term finance.
No matter how much fundamental stock analysis is conducted on a growth company there is a risk of capital loss. Any business in its early stages will be vulnerable regardless of their product. Ultimately, no matter how much analysis is done, it will be a subjective decision.