Stock Picking Technique: Growth Investing
Some investors prefer buying stocks at a bargain while others like investing in companies with a large growth potential. Growth investing is essentially the process of investing in companies that are currently growing
Some investors invest with hopes of receiving steady income from dividend payments while others prefer to invest in companies with large capital growth potential. Investing for capital growth is commonly referred to as Growth investing.
Growth investing is essentially the process of investing in companies that are currently growing and are expected to continue their expansion over a substantial period of time.
Investors like the idea of picking stocks but may find this stressful, so they tend to use the ''Growth at a reasonable price strategy''(GARP). This is a strategy that ensures emphasis is placed on a company’s capital appreciation. Such companies must show signs of above average growth, even if it is expensive to acquire their stock.
Understanding a company’s net earnings is essential. This doesn’t mean simply knowing their current earnings, but also comparing their historical earnings as well since this enables an investor to evaluate current earnings relative to a company’s past performance. Also, a company’s earnings history provides a clearer indication of the probability of the company generating higher future earnings.
The American investor, Peter Lynch pioneered the concept of growth investing popularly called GARP. He advocated the P/E ratio valuation metric because, it tells how earnings of a company compare to the company’s share price. The P/E ratio can be found by taking the current share price and dividing it by the earnings per share (EPS) price of that company.
For a company to have a P/E ratio, it must at least be operating profitably and have earnings to report to the public. A high P/E ratio, say 30, indicates that the company is currently trading at 30 times its earnings and it would take about 30 years, (without compounding) to recoup your investment.
Growth investors prefer buying stocks with a higher P/E ratio because there are high expectations that the company will see significant growth. These high expectations usually come with a higher price tag for the stocks.
GARP investors also tend to prefer businesses with a lower price to book (P/B) ratio. The P/B ratio is used to gauge how much value the market places on the book value of the company in question. It is found by dividing the current share price by the book value per share.
The reality is that there are different techniques that growth investors use in finding investments to complement their existing investment portfolio. There are also different tools used to spot growth stocks and purchase them at relatively lower prices, with the belief that these companies will experience considerable capital appreciation growth in the future.
Smart investors educate themselves and use these different approaches to identify investments with the greatest potential for providing future profits.