Growth investing is a type of investment strategy that concentrates on increasing the value of the financial assets one has, i.e. capital appreciation rather than annual income or dividends.
An individual who practices growth investing is known as a growth investor. He or she seeks out companies that have promising growth potential, even if their stock prices are high in terms of their price-to-book or price-to-earnings ratios.
The growth investor looks for companies that are more likely to reinvest their profits in acquisitions or expansion projects, rather than use them to pay out dividends to stockholders.
Warren Buffett said “The investor of today does not profit from yesterday’s growth.” He meant that we should really look to the future when determining whether to buy shares in a company.
Growth investing vs. value investing
Growth investing contrasts with ‘value investing’, a strategy in which the investor looks for and buys shares for less than they are worth.
American billionaire Warren Buffett, arguably the most successful investor of the 20th century, believes that the concepts of growth and value investing are basically the same.
In his 2000 annual letter to Berkshire Hathaway shareholders, Mr. Buffett wrote:
“Market commentators and investment managers who glibly refer to ‘growth’ and ‘value’ styles as contrasting approaches to investment are displaying their ignorance, not their sophistication.”
Mr. Buffett insists that all investing is about value. When we assess a firm’s growth prospect, we are simply looking at one part of gauging value. Strong growth in profits and sales can add a lot of value to businesses whose shares may initially look expensive.
Pundits say that while growth funds generally have the potential for higher returns, they also represent a greater risk, in comparison with value funds. When overall stock prices are going up, growth funds tend to outperform the market. However, they also have the habit of performing worse than the market when stock prices fall.
The growth investor has a higher tolerance for risk and a longer time horizon than the value investor.
America’s fourth largest bank (by assets) Wells Fargo said the following regarding growth investing:
“Growth stocks represent companies that have demonstrated better-than-average gains in earnings in recent years and are expected to continue delivering high levels of profit growth. While earnings of some companies may be depressed during periods of slower economic growth, growth companies may potentially continue to achieve high earnings growth regardless of economic conditions.”
Growth investing is one of several investment philosophies, which include contrarian investing, socially responsible investing, fundamental investing, contrarian investing, and value investing.
Video – What is growth investing?
This Investopedia video explains what growth investing is and what growth investors focus on.