You won’t find growth companies that pay big dividends to shareholders, Phil Oakley explains in MoneyWeek
Growth companies reinvest all the company’s profits and cash flows back into the business so it can grow.
These companies are often small stocks. And it’s not uncommon for them to be making losses.
For example, a company may need to invest in new factories and equipment to make its products. Or it may spend a lot of money researching and developing its next winner before it makes any sales.
This means that you won’t find these kind of companies in the bargain basement of the stock market. Their shares will look expensive relative to their profits or assets.
Value or income investors tend to steer clear of these types of stock.
You can do very well buying growth companies.
Growth investing can be a risky approach
However, you have to do your homework. This goes for all styles of investing, but it’s vital when buying growth stocks. Back the wrong company or pay too high a price, and you often have little to fall back on whilst facing big losses.
So when you look at a growth stock, you have to have a lot of confidence in a company’s products and business model. You have to believe that it will be able to sell its products to lots of customers, without lots of competition.
The classic example of investors ignoring this advice was the dotcom boom at the end of the 1990s. People thought the Internet would see rapid growth. This turned out to be true, but they ignored the fact that it allowed competition to flourish as well.
Some companies that floated on the stock exchange at very high valuations became worthless very quickly as their business models and products met with competition.
Another example is the airline industry.
The business has grown rapidly. More people are flying than ever before. But this rapid growth in air travel has not made investors in airlines rich.
The airline industry has made a cumulative loss since it began. This is because there is too much competition.
Don’t overpay for growth stocks
The other thing to bear in mind is the price you pay for growth stocks. There are certain large successful companies, such as Coca-Cola, Walmart or Procter & Gamble that generally fall into the ‘growth’ category rather than ‘income’ or ‘value’.
That’s because these companies are so highly prized that they rarely, if ever, become ‘cheap’ in investment terms. Yet their consistent ability to grow profits has still seen long-term investors do well.
But these companies are not a buy at any price. Overpaying for growth is a common mistake that investors make. And it’s a major reason for losing money.
So while you won’t find these stocks in the bargain basement, you are looking to pay reasonable prices, not silly ones.
There you have it, how you can benefit from the growth investing approach.