Growth investing is a strategy of investment that entails investing in companies that have a potential to grow faster than its peers. Usually, the growth stocks outperform their peers as well as the industry and this is amply reflected in the premium valuation commanded in the market by the stocks of such companies.
The growth investing strategy is in contrast to value investing, where the value investor looks for investing in stocks that are deemed to quote at a market price that is lower than the intrinsic value of the stock.
So, how does one identify the growth stocks? There are some popular markers to identify such stocks. Growth stocks usually have low dividend yields but above-average valuations because these companies are not very generous about distributing their profits to the shareholders as they prefer ploughing back profits into the business to expand and grow faster.
The high valuations commanded by these stocks is measured in terms of price-to-earnings (P/E) , market capitalisation-to-sales and price-to-book value ratios (P/B). These multiples reflect the high expectations and confidence of the investors in the future growth of the company.
The growth stocks flourish during periods of expansion of the economy as the macro-economic environment add to the momentum of growth of these companies.