When investors practice growth investing, they find stocks that they feel have good potential for growth. This is stock in a company whose earnings are expected to outpace the industry or overall market. Investors interested in maximizing their capital gains utilize this investment strategy. Growth investing can be rewarding, but there are also substantial risks.
Growth investors purchase shares of companies that trade higher than the intrinsic worth of the entity. The methodology is that the company’s worth will increase, exceeding current valuations. In essence, the revenue and earnings growth will translate to an increase in stock price. Investors engaging in this practice often look to young companies or those within industries that are rapidly expanding. The profit to investors is realized through capital gains rather than dividends.
The risk comes in because there is no true way to evaluate the future growth potential of a company. Investor judgment and interpretation is involved in this practice, making it relatively subjective. The application of standard analytical guidelines must be made in the framework of the company’s situation. What may appear to be a good investment based on certain factors may actually be unwise when others are taken into consideration. It is up to the investor to select which criteria to employ during the analysis.
An innovative technology could become the industry standard or it could be rejected by its consumers. When the market falters, the stocks of growth investors drop first and fastest, so these investors need to sell before that happens or ride out the losses. Growth investors need to keep up with not only the market but also geographic regions, industries, stocks and new products, services, and technologies. This is a huge amount of information to take in and decipher in order to make an investment decision.
During the dot com boom of the late 1990s, investors who practiced growth investing receive a windfall of returns. However, there is no guarantee that what appears to be a company or industry poised for growth will deliver on that hope. There are many internal and external factors that could cause it to go straight down rather than moving in a positive direction. Practicing a growth investment strategy involves subjective thinking, which can be very risky. This method is definitely not ideal for all investors, especially novices.
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