How to Identify a Growth Stock

As discussed in the last post, growth stocks are stock in companies that are growing rapidly. They tend to be young companies, or companies that have gone through a serious contraction to the point where they are small again. Growth company stocks will provide the greatest return over long periods of time, but will also provide the most unpredictable returns. They are therefore mainly what you want to own if you’re investing for decades, but not what you want to buy if you have only a year or two or really, really need the money at some near point in the future. 401k fund at 20? Yes. College fund when the kid is 16? Probably not.

So that question then becomes: how do you find these growth stocks? One of the easiest things to do, and really what you are forced to do in most 401k accounts, is to buy a growth fund. Most funds that specialize in growth stocks will have the word “growth” in their name. If not, the fund’s prospectus will have a diagram with little boxes showing whether it is value, growth, or a blend (a combination of both). Like everything, in general if you have a choice you’ll do best buying the fund with the lowest expense ratio. (Think index fund or ETF.) When comparing you should also check the size of the stocks in the fund, however, so that you compare funds that are both large cap growth, for example, instead of one that is large cap growth to one that is small cap growth. Again, look at the little diagram in the prospectus.

Finding individual stocks that are growth stocks — which is one of the criteria for what I would call serious investing stocks — requires a little more work, but not that much. Once again, you are looking for stocks that are small enough that they have the ability to grow, but also which have shown that they are well-managed and actually will grow. Some stocks start small and stay small, if they stay around at all. Things to look for are:

Earnings are growing regularly at a sustainable pace. I like stocks with earnings growth in the 10-20% range.

2. The company has room to grow. If there is one on every corner, how can it grow? Many growth stocks will not be household names. Maybe find a company that is only in your area, or not in your area at all. 3. The stock price increases regularly. Some of the best stocks are found by looking at the price graphs. Look for one that you could lay a ruler across the ten-year chart and have it nearly follow the ruler. Steady growth is what you want. 4. No dividend. Normally a dividend is a good sign, but if a company is paying a dividend, especially a big dividend, it isn’t putting all available resources into growth. You want no dividend today so that the company can pay a bigger dividend tomorrow. 5. Small or medium market cap. You want a stock with a market capitalization, defined as the number of shares times the price of the stock, in the tens to hundreds of millions, not the billions of dollars. Again, you want room to grow.

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Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.