Growth Investing Online Philosophy

What is growth investing?

Growth investors seek the stocks of companies that generate consistent increases in sales revenue and net income from one year to the next.  The rate of sales and earnings growth among these stocks is generally greater than the majority of their peers. These types of stocks usually offer little or no dividend payment to investors since most of the earnings is retained and reinvested for future growth.

Growth stocks typically have a high PE ratio because investors are willing to pay a premium for consistent and growing earnings.  The key is to invest in companies where the price paid for growth is less than the value of that growth. 

Dell Computer is prime example of a growth stock. Its earnings have grown more than 40% per year for much of the 1990s. Its stock price has also posted dramatic gains throughout this time period.

The overall evidence is that growth stocks lag value stocks over long periods, if PE ratios or PBV ratios are used as proxies for growth and value.

Growth Stocks

• Typically High PE ratio

• Typically High PBV ratio

Value Stocks

• Typically Low PE ratio

• Typically Low PBV ratio

However, there have been extended time periods where growth investing has outperformed value investing.

Growth investing seems to do much better when the overall growth rate of the market is good. For example, active growth investors seem to beat growth indices more often than value investors beat value indices.

Small Cap Investing

Studies have consistently found that smaller firms (in terms of market value of equity) earn higher returns than larger firms of equivalent risk, where risk is defined in terms of the market beta.

There may be additional risk in investing in small cap stocks because far less information is available on these stocks. Analysts follow fewer small companies.

Dimson and Marsh examined stocks in the United Kingdom from 1955 to 1984 and found that the annual returns on small stocks exceeded that on large stocks by 7% annually over the period.

Bergstrom, Frashure and Chisholm report a large size effect for French stocks (Small stocks made 32.3% per year between 1975 to 1989, while large stocks made 23.5% a year), and a much smaller size effect in Germany.

Hamao reports a small firm premium of 5.1% for Japanese stocks between 1971 and 1988.