The best investing strategies in the world have names to remember them by.
There are some fanciful ones out there: strategies that focus on one number or another, with long titles that spell out something jazzy in an acronym you'll forget in a few months.
Or, there's the other side of the spectrum, where the name of the game is simply, “make money.”
Both sides are at fault here.
Acronyms and vague investment goals are not the path to good investing. Do you know what is?
Solid research and investment criteria.
The problem here is that the research is vast, and any number of criteria can add up to a fantastic — or disastrous — stock pick.
Your best bet is to stick with the tried-and-true strategies that have already proven themselves worthy of investor attention.
That's why today, we would like to introduce you to growth investing.
For those of you already in-the-know about this particular trading strategy, this will just be a refresher course. And for newer readers: get ready to learn.
The first step is explaining what growth investing is... by explaining what it is not.
Most often, growth investing is compared to value investing.
Value investing does what it says on the tin: it targets companies with attractive valuations.
But it’s not just any value; this approach looks at the company's “intrinsic value” in the moment, and uses metrics that try to predict whether or not a company will one day reach that value and put the profit right into the pockets of investors.
Value investors look for companies trading below these intrinsic values on the market.
The actual value depends on an individual investor's criteria. Most often, this includes a company's price-to-earnings ratio (P/E), which determines if a company is trading for more or less than it is earning.
Another number sometimes used is the company's PEG, or P/E to growth ratio. Value investors would want a low PEG, as that would imply the company is currently undervalued.
In short, value investing looks for stocks with a:
- Low P/E
- Low PEG
- Bargain price
Some value investors look for stocks not only trading at bargain prices, but also those that pay out handsome dividends. Value investing can have the advantage of more immediate gains than some other longer-term strategies.
Charles Mizrahi, editor of our sister site Wealth Daily, uses this strategy in his portfolios, and it's helped him become one of the most successful traders on Wall Street.
However, there's always the chance that the company may never reach a better value.
Anything could shut the company down, or reduce that value quite a bit. And then you, as the investor, are out whatever money you put into the stock — or more!
To avoid this particular kind of risk all together, you may give growth investing a closer look...
Growth investing takes a slightly different approach.
Rather than looking at a stock's value today, growth investors look to the value a company could bring in tomorrow... or, rather, months and years down the road.
You see, growth investing looks for companies with high historical earnings and sales, and uses that to predict the probability of future success. There's no “intrinsic value,” just the likelihood that the company's value will keep on growing.
The creation of this investment system is credited to Thomas Rowe Price, Jr., who defined and used growth investing in his company, T. Rowe Price.
Later, the investing strategy was modified by Peter Lynch and proven moreover by Warren Buffett.
The National Association of Investors Corporation (NAIC) is one of the biggest advocates of growth investing, and has several resources for teaching its members about the practice.
A few of the things NAIC asks growth investors to consider are historical earnings growth, forward earnings growth, efficiency of management, and the potential for the stock price to double in just five years.
The metrics used to figure these things out include revenues, earnings per share, and return on equity. These all ensure that the company is stable now and will continue to grow in the future.
Growth investors also look at the PEG, but prefer it to be higher than market average to indicate future growth. But one thing investors have to keep in mind is whether the company has the potential for growth, not just the means for it.
This is why growth investors will also consider companies that are already large: they have the excess cash for further expansion. Often, brands that have become household names qualify here.
Basically, growth investors look for stocks with a:
- High P/E
- High PEG
- Fair price
However, there are a few caveats...
Famous investor Warren Buffett was once quoted as saying that high growth can “destroy value if it requires cash inputs in the early years of a project or enterprise that exceed the discounted value of the cash that those assets will generate in later years.”
Basically, if that quick and fantastic growth costs too much, the company will go broke anyway, and break its investors as well.
This can be especially dangerous for larger companies. Growth investors are less interested in buying stocks at a bargain price, and are therefore taking a bigger risk if they pay more and it doesn't pan out.
That's why many growth investors today are taking a fresh look at the strategy...
¿por qué no los dos? (Why not have both?)
If you hadn't guessed from the quote above, Warren Buffett is acutely aware of the possible pitfalls of investing with just one strategy in mind. And so it should come as no surprise to know that he also said this: “growth and value investing are joined at the hip.”
One of the spin-off strategies of growth investing, called growth at a reasonable price (GARP), takes this statement to heart. Pioneered by Peter Lynch, GARP combines the main ideas of growth and value investing to create a strategy that looks for high growth at low prices.
This minimizes some of the risk involved in the individual practices, and saves investors a lot of grief — and cash.
After all, who wouldn't want both current value and future growth in their portfolio?
Of course, this still involves some expenditure on the part of the investor. The prices aren't generally as low as in value investing, but GARP investors also don't bother looking at long-established and high-priced companies.
Buffett also points out, "It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.”
In other words, you get what you pay for. Sometimes that bargain just isn't worth it.
GARP investors will look for a company trading at a fair price, generally with a PEG of 1 or less that indicates earnings and growth are in line with each other.
And so, GARP investors look for stocks with a:
- Low to moderate P/E — Not over- or undervalued
- PEG of 1 or less — Indicates earnings in line with growth
- Fair price — Not bargain-bin, but also not too expensive for gains
Let's look at one viable example: Potbelly Corp. (NASDAQ: PBPB).
With a market cap of just $303 million, it qualifies as a small-cap investment, which both value and growth investors look for.
The company's P/E is 40.18 at the time of writing, which is slightly higher than the industry average of 37.97. While the value investing side would assume this means the company is over-valued, the growth investing side sees this as confidence in the company's future earnings.
And for now, Potbelly's PEG is 1.65, meaning growth is set to be higher than P/E in the next 12 months!
The company's current stock price is just $12. This is still well below its 52-week high of $14.55, suggesting that it's currently being sold at a discount to its possible value.
This point is driven home even futher by the fact that the drop, which you can see in the chart below, was not caused by a decrease in revenue, net income, or earnings per share (all of which rose in the most recent quarter), but by slightly lower than expected store sales, a problem which is plaguing the entire industry, not just this promising company.
Of course, there are a plethora of other metrics out there, and any number of investors ready to use them. But with investors like Thomas Rowe Price, Jr., Peter Lynch, and Warren Buffett behind this strategy, it's definitely worth some careful consideration.
Energy & Capital