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Investing in Growth Stocks

Adam Levy

Updated: Oct. 5, 2020, 5:14 p.m.

Investing in growth stocks can be a great way to earn life-changing wealth in the stock
market. The key, of course, is to know which growth stocks to buy -- and when.

To help you get started, here’s a handy guide to growth investing. With these tools and
strategies, you’ll be able to position your portfolio for long-term success with growth
stocks.

What is a growth stock?

Growth stocks are companies that increase their revenue and earnings faster than the
average business in their industry or the market as a whole.

Often a growth company has developed an innovative product or service that is gaining
share in existing markets, entering new markets, or even creating entirely new industries.

Businesses that can grow faster than average for long periods tend to be rewarded by the
market, delivering handsome returns to shareholders in the process. And the faster they
grow, the bigger the returns can be.

Unlike value stocks, growth stocks tend to be more expensive than the average stock in
terms of metrics like price-to-earnings, price-to-sales, and price-to-free-cash-flow ratios.
Yet despite their premium price tags, the best growth stocks can still deliver fortune-
creating returns to investors as they fulfill their awesome growth potential.

Did You Know...

Growth stocks are companies that increase their revenue and earnings faster than the
average business in their industry or the market as a whole.

Great growth stocks

To provide you with some examples, here are 10 excellent growth stocks available in the
stock market today:

CAGR = compound annual growth rate. Data sources: Morningstar, Yahoo! Finance

As this list shows, growth stocks come in all shapes and sizes. They can be found in a
variety of industries, both within the U.S. and in international markets. In fact, while all
the stocks on this list are larger businesses, smaller companies can be fertile ground for
growth investors, too.

A great way to invest in a wide variety of small-cap growth stocks is via an exchange-
traded fund (ETF) such as Vanguard Small-Cap Growth ETF (NYSEMKT:VBK). This

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fund tracks the performance of the CRSP US Small Cap Growth Index, which gives
investors an easy way to invest in roughly 580 small-cap growth companies all at once.
Importantly, this ETF has an ultralow expense ratio of 0.07%, meaning that investors will
receive nearly all of the fund’s returns, with only a small amount in fees going to
Vanguard. (In fact, an annual expense ratio of 0.07% equates to only $0.70 in fees per
$1,000 invested per year.)

Image source: Getty Images

How to find growth stocks

To find great growth stocks, you’ll need to:

1. Identify powerful long-term market trends and the companies best positioned to
profit from them
2. Narrow your list to businesses with strong competitive advantages
3. Further narrow your list to companies with large addressable markets

Identify trends and the companies driving them

Companies that can capitalize on powerful long-term trends can grow their sales and
profits for many years, generating wealth for their shareholders along the way. Such trends
-- and the companies that can help you profit from them -- include:

E-commerce: As more people shop online, Amazon and Shopify are well
positioned to profit within the U.S. (and many international markets). Alibaba

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(NYSE:BABA) and JD.com (NASDAQ:JD), meanwhile, dominate e-commerce in

China. And MercadoLibre (NASDAQ:MELI) holds a leading share of the online
retail market in Latin America.
Digital advertising: Facebook (NASDAQ:FB) and Alphabet (NASDAQ:GOOG)
(NASDAQ:GOOGL) own the lion’s share of the digital ad market and are poised to
profit handsomely as marketing budgets shift from TV and print to online channels.
Digital payments: Square (NYSE:SQ) is helping to accelerate the global shift
from cash to digital forms of payment by allowing businesses of all sizes to accept
debit and credit card transactions.
Cloud computing: Computing power is migrating from on-premise data centers to
cloud-based servers. Amazon’s (NASDAQ:AMZN) and Alibaba’s cloud
infrastructure services help make this possible, while Salesforce.com
(NYSE:CRM) provides some of the best cloud-based software available.
Cord-cutting and streaming entertainment: Millions of people are canceling
their cable subscriptions and replacing them with less expensive and more
convenient streaming options. As the global leader in streaming entertainment,
Netflix (NASDAQ:NFLX) offers a great way to profit from this trend.

The key is to try to invest in these types of trends and companies as early as possible. The
earlier you get in, the more you stand to profit. However, the most powerful trends can last
for many years and even decades, giving you plenty of time to claim your share of the
profits they create.

Prioritize companies with competitive advantages

It’s also important to invest in growth companies that possess strong competitive
advantages. Otherwise their competitors may pass them by, and their growth may not last
long.

Some competitive advantages are:

Network effects: Facebook is a prime example here. Each person who joins its
social media platform makes it more valuable to other members. Network effects can
make it difficult for new entrants to displace the current market share leader, and
Facebook’s more than 2 billion users certainly make it unlikely that a new social
media company will displace it.
Scale advantages: Size can be another powerful advantage. Amazon is a great
example here, as its massive global fulfillment network is something its smaller
rivals will find extremely difficult to replicate.
High switching costs: Switching costs are the expenses and difficulties involved in
switching to a rival product or service. Shopify -- which serves as an online retail
operating system for more than 1 million businesses -- is a great example of a
business with high switching costs. Once a company begins to use Shopify as the core
of its online operations, it’s unlikely to go through the hassle of switching to another
competitor.

Pinpoint companies with large addressable markets

Lastly, you’ll want to invest in businesses with large addressable markets -- and long
runways for growth still ahead. Industry reports from research firms like Gartner
(NYSE:IT) and eMarketer -- which provide estimates of industry sizes, projections for
growth, and market share figures -- can be very helpful in this regard. The larger the
opportunity, the larger a business can ultimately become. And the earlier in its growth
cycle it is, the longer it can continue to grow at an impressive rate.

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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The
Motley Fool’s board of directors. Suzanne Frey, an executive at Alphabet, is a member of
The Motley Fool’s board of directors. Randi Zuckerberg, a former director of market
development and spokeswoman for Facebook and sister to its CEO, Mark Zuckerberg, is a
member of The Motley Fool's board of directors. Adam Levy owns shares of Alphabet (C
shares), Amazon, and Facebook. The Motley Fool owns shares of and recommends Alibaba
Group Holding Ltd., Alphabet (A shares), Alphabet (C shares), Amazon, Facebook,
JD.com, MercadoLibre, Netflix, Salesforce.com, Shopify, Square, and Vanguard Small-Cap
Growth ETF. The Motley Fool recommends Gartner and recommends the following
options: short January 2022 $1940 calls on Amazon and long January 2022 $1920 calls
on Amazon. The Motley Fool has a disclosure policy.

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