What Is Growth Investing? - dummies

By David Stevenson

For many UK investors, stocks and shares are all about the search for growth stocks, where they can reap huge rewards from a share price that goes up many times in value. Here, look at this perhaps most excitable group of investors and their hunt for fast-growing companies and spectacular profits.

To help you get under the skin of growth investing, take a look at the ideas of two of the greats: Richard Driehaus and William O’Neil.

Focusing on profits

For Driehaus and his colleagues, the growth-orientated objectives are brought to life by using a number of key measures including an insistence on earnings growth. Investors need to start with an understanding of profits generated by a company and how the growth in those profits is the principal factor in determining the share price over the long run.

Only through constant and sustained earnings growth can cash flows be increased, dividends raised and the value of the business ‘worth’ be expanded. Therefore, investors need to look out for accelerating sales and earnings growth as well as the odd earnings surprise (when the company surprises analysts by producing profits above their estimates).

As a Driehaus follower, you need to become hugely interested in a share’s technical price data, including price support levels, volume characteristics and relative strength rankings, as well as look at sector and industry relative strength. By combining an analysis of the company and its growing profits plus its technical share data, you can ‘make early identification of companies on the threshold of rapid stock price appreciation’.

Following the profits

Many of Driehaus’s ideas are echoed by another legendary growth investor, William O’Neil, who says that finding growth stocks is all about examining ‘winners of the past to learn all the characteristics of the most successful stocks’. The fruits of this research are contained in the CAN SLIM approach.

O’Neil passionately believes that stocks sell for what they’re worth and stocks with low PE ratios are probably correctly priced by the market. What matters to O’Neil is that the firm whose shares you’re buying is growing fast and that the markets recognise this fact.

For O’Neil (and Driehaus) the key test of quality is profits. You need to look for a minimum increase of 18‒20 per cent in quarterly earnings compared with the same quarter last year. Specifically, you want to find shares where a kind of earnings growth engine is kicking in, and where new products or services are about to be launched.

O’Neil sums up his philosophy as follows:

We’re buying companies with strong fundamentals, large sales and earnings increases resulting from unique new products and services and trying to time [those] purchases at a correct point as the company emerges from consolidation periods and before the stock runs up dramatically in price.