Dear long-term investor, are you considering getting started with growth stocks? Or are you looking for cheap growth stocks or the best growth stocks? Unfortunately, this is not always so easy. Valuing growth companies financially is not easy. Certainly not when it comes to fast-growing technology companies.
In this article, you will read everything about growth stocks. From how to find the best growth stocks to how to look for low-cost growth companies that can potentially make a lot of money. We also discuss the risks and look at scenarios of investing in relation to the desired return.
On to growth!
Table of Contents
What are growth stocks anyway? How do they differ from dividend stocks, or value stocks? Logically, "growth" is the main focus here. Growth stocks is a term that refers to shares of a growing company. Companies that grow rapidly can realize very high returns in the long run. On the other hand, because growth is central, there is increased risk. After all, many growth companies don't even make a profit. And those that do, reinvest it in its business activities. Anything to just grow as fast as possible. But of course, there are also scenarios in which this goes wrong.
What are growth stocks? In the context of the type of stocks, this is the riskiest group. However, it is a broad term. Many types of companies can fall under it.
The first important difference is this: does the company achieve a lot of growth in sales, profits or sales and profits?
Growth stocks that grow faster than average in profits are a very good move. This type of stock often falls under Value stocks. After all, you are paying a share price now for a company that will be worth much more in the future. Apparently, that market missed something. Something you have come across in analysis.
The riskiest are growth stocks that are purely increasing in revenue. Think small cap stocks that often achieve more than 50% revenue growth per year. However, we often see that they burn more money than they create. A negative cash flow is the result. Without additional funding, they go bankrupt. This is the type of growth stock we want to avoid.
Let's take a look at how to find the best growth stocks.
How do I find the best growth stocks? For this we need to look at two things, (1) growth perspective and (2) financial valuation. In essence, we want to buy the best growth stocks at an attractive stock price. To find the best growth stocks, we need to conduct careful research. The most important factor is corporate strategy.
Business strategy is crucial to a company's future growth. It includes a number of crucial elements, including:
The best growth stocks usually do not have a cheap price. We often pay a premium because it has promising prospects. The most promising stocks are more expensive because everyone wants them.
Therefore, in our opinion, the business strategy is of great importance. We need to determine if the current stock price is justified. Or perhaps too low, because the market misjudges how great its potential really is.
A successful example of a best growth stock is The Trade Desk (TTD). This stock we shared early on within our equity research on our community. We are at a very high return.
Those who had invested €500 in TTD from the beginning would have €14,623 after 5 years.
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Sometimes we find the best growth stocks by looking at cheap growth stocks. As indicated, we rarely find it. These are the unique gems in the market. In this regard, we can describe cheap growth stocks as:
The best growth stocks are cheap growth stocks with unexpected business growth. One that analysts did not expect could have achieved so much growth. This could be because the company is performing better than expected. Because the economy is unexpectedly favorable. Or because the growth stock is "under the radar," meaning not many people know about it yet. This is called a "hidden gem".
An example of a cheap growth stock was Enphase Energy (ENPH). By mid-2017, this company, which designs energy solutions, was pretty much written off. Then came a major tipping point. Enphase developed new high-quality software. And the solar market began to grow at a rapid pace. This combination led to unprecedented growth:
A deposit of €500 would have grown to €48,376 within 5 years! And at the peak of the end of 2021, this amount would even have been €86,508 (!).
In other words: in theory, with €10,000 we can acquire a capital of €500,000 (or more) within just 5 years.
This is the reason to invest in growth stocks.
But of course, there are also many risks. For example, Enphase might as well have gone bankrupt (in 2017). Cheap stocks are often in very bad shape: both strategically and financially. And in this case, we need a big dose of luck. But with a lot of research, it is possible to find the best growth stocks. And with a little luck, they are also very cheap.
You understand: investing in growth stocks is for the advanced. Fortunately, it can be learned!
Where can we buy growth shares? This is possible at almost every online broker. Here it is a matter of choosing the best investment platforms. We have no control over how a growth stock will perform over time. This depends on the strategy and its execution. Market conditions such as politics and economic developments also play a major role.
We do, however, have control over the costs. We prefer to buy growth shares as cheaply as possible. Not just a cheap share price, but also cheap transaction costs. The cheaper, the better.
In addition to low transaction costs, supply is also important. In particular, small growth stocks such as small cap stocks are not found at every investment platform. The "hidden gems" are "hidden" for a reason. Therefore, in addition to low transaction costs, we also want to choose brokers with a large product range.
We recognize a large range by the number of stock exchanges. Some investment apps offer only 10 stock exchanges worldwide. Others offer 50 or even 135. Usually, we are comfortable with 30+ stock exchanges worldwide. In this way, we can buy growth stocks in the most prominent countries on a global level.
Want to know where we buy growth stocks cheaply?
We compare our favorites. Click here for the best investment platforms.
There are several angles to the question "how to invest in growth stocks". Obviously, this is done by purchasing shares issued by growth companies. Growth companies are characterized by strong annual revenue growth. Usually, but not always, this is accompanied by substantial losses.
The essence of investing in growth stocks is that you get in early to unique companies that will make a lot of profits in the future.
Well-known examples are Amazon, Apple, and Netflix in its early years. It is a stage of solid growth. The company invests a lot of capital because they want (need) to become the biggest. Usually a new technology and/or revenue model at the base of the growth curve.
How best to invest in growth stocks? My tip: look at the business concept. The value proposition. Do they have a unique concept? Are they doing something radically different from the current market? And is there a great need for this concept? Does it solve a big problem and offer more benefits?
Let's take Netflix as an example. Everyone loves movies and series. It is a big market. But not many want to go to the video store continuously. And what are you going to rent then? If it's a bad movie you think this is a waste of money. Netflix solved a big problem: video on demand. In this case it was accompanied by a new technology and a different revenue model (membership). This did not happen overnight. Netflix had to reinvent itself. And only then did it become a great success.
In all these years Netflix has mainly made losses and invested a lot of money in growth. After all, in its revenue model, "the winner takes all" applies. This is why you can make exponential returns by investing in technology stocks.
The right entry moment is important for growth shares.
How to invest in growth stocks? In summary, these are important factors:
Investing in growth stocks is difficult. And very risky. Companies can go bankrupt and then you lose your money. Later I'll tell you how you can deal with this.
Additional complexity: the first is not always the best. Amazon was not the first online retailer. Google wasn't the first search engine. Apple was not the first with a "walkman."
As a novice investor, it is advisable to avoid growth stocks. Why take unnecessary risks?
Know that there is an alternative: choose themed ETFs focused on growth stocks. The best example are the risky ARK ETFs. These are among the best ETFs at eToro. The advantage of theme ETFs is that despite the high-risk profile, they offer more risk diversification (e.g. 35 - 50 growth stocks).
The main disadvantage of growth shares is their extremely risky nature. This leads to potentially large losses. On the other hand, this is also the greatest advantage: investing in growth shares can lead to exponential returns. So depositing small amounts can lead to substantial profits in the long term. Bear in mind that you should only invest with money you can afford to lose. Apply at least a proportional spread among 20 to 40 growth stocks. Finally, it is not wise to invest a large part of your capital in growth stocks only. (see below).
It is important that you get in on the right growth stocks early. This takes time and effort. There are many options. The 5% best stocks give the highest results. The rest perform (slightly above) average or worse. So you have to do your best to find the right growth stocks. And if you don't want to or can't do this, a themed ETF is definitely a better choice.
For example, I do full-time research on unique stocks. Some of them are extremely profitable. Others are among unique growth stocks. I aim for potentially x5 - x10 returns per share. Especially with growth stocks, it is crucial to get in early. I share my research on the HIM Community.
The temptation to invest a lot of money in growth stocks is great. Especially small growth stocks (micro and small caps) can give exponential returns. This is exciting. And it can potentially yield high profits.
Unfortunately, potentially high returns also come with high risk. This means that, with improper investments, you can easily lose -50% or more. Growth stocks are risky. Very risky.
For example, at the time of writing I am at -60% with a favorite growth stock. Boring? Heavily crappy yes! In this matter, I must be patient. I have done my research. I have high expectations (as do others). It is what they call a "hidden gem". It may just take some time for this company to live up to its potential.
This is a big risk with growth stocks. As a full-time investor, I bought a growth stock at a price that was way too high. Partly a mistake, but partly not. The financial valuation of growth shares is no sinecure.
Another risk with growth shares is that the potential is not fulfilled. We often pay a premium because we expect a lot of growth in the (near) future. Does this growth not materialize? Then we lose money.
Successful long-term investors create a diversified investment portfolio. Create a healthy balance between lower and higher risks. It is unwise to invest 100% in growth stocks. Even if, like me, you have a high-risk profile 😉 .
In addition to allocation, diversification is also important. Some people swear by a small portfolio. For growth stocks, however, this is too risky in my opinion. It is wise to include at least 20 growth stocks in your portfolio. With for example 1% per growth share (suggestion).
You can expect heavy price volatility in the short term. It is not inconceivable that your portfolio will fall to -50%. If you are unlucky, this can even be more. About 10% of your growth stocks will perform exceptionally well. Don't sell these winners too early. They bring up the average return. And don't hold onto your losers for too long.
Growth stock ETFs can be an interesting middle ground. In fact, they are a much better alternative for small, retail investors. Why risk investing in the best growth stocks when we can also buy the whole haystack?
We recognize the best growth stock ETFs by the fund's (1) strategy, (2) growth market and (3) selection of growth companies.
Examples of interesting growth equity ETFs:
Don't have much knowledge and experience with stocks (which is totally fine)? Then it's smarter to invest in the best ETFs. Saves you a lot of time and effort. Provides less risk. And possibly even higher returns.
What is the return on growth shares?
Let's look at a few scenarios. A diversified portfolio with 20 - 40 growth stocks can yield around 10 - 20% per year. The better your research, the higher your return.
Let's assume we invest up to 20% of our money in growth stocks. And that these yield on average 15% return per year. This is possible if you do good research, buy strong growth companies and hold them for the long term.
The 20% limit of course gives restrictions. With a monthly deposit of €500, €100 would go to growth stocks. At €1000 this is €200 p.m. And let's look at €500 monthly investing in growth stocks.
You see that both the return and the amount of money are decisive when investing in growth shares. In particular, the amount of return has a strong impact on the long term. This is an argument in favor of including growth stocks in your portfolio.
However, keep in mind that these are scenarios. In practice, taking more risk can also lead to lower returns. Very few private investors achieve above-average returns. The market average is 8 - 10%. And therefore this is an argument against investing in growth stocks.
The stock market has a pattern. Normally it follows the economic cycle from low to high. Once in a while a "shock" or "black swan event" occurs. These are the well-known examples such as the dot.com, financial and covid-19 crises. In general, the best market timing to invest in (growth) stocks is at the transition from downturn to upturn. This looks like this:
Of course, looking back is very easy. This chart has a thirty-year scale, while investing is done on a day-to-day basis. Don't let media reports fool you. Try to look at the big trends.
Moreover, the chart shows that "time in the market beats timing the market". The earlier you get in, the better. Based on the chart, we cannot draw any other conclusion.
Specifically, to when to invest in growth stocks there are key "moments" such as (not limited to):
You can see the effect of the economic climate on the stock market in the chart. Investing in growth stocks is especially interesting when the economy is fully recovered and investors become more confident (market sentiment).
The political climate is important and varies from country to country. Investing in growth stocks that operate within politically favorable climates is evident. Look at factors such as stimulus, innovation levels and tax breaks (for start-ups).
The interest rate level is also very important for the stock market. For growth companies, this weighs extra heavily. They need a lot of cash to invest (for growth). Borrowing cash costs money. The higher the interest rate, the more expensive it is. When interest rates are low, companies with cheap money can grow faster. This has been the case for many years now.
Finally, market sentiment is key. Are investors euphoric? Then they take more risk such as with growth stocks. Are they pessimistic? Then more money will flow into lower-risk investments like bonds, ETFs and Value stocks.
Apart from this, I believe in looking for unique growth companies above all. They can thrive in any climate, as long as they offer the right market fit at the right time. For example: Google was not the first search engine.