When people envision the stock market, particularly those who are not well versed on the subject, they tend to think of growth stocks. They think of the story of that one person who made a fortune off a stock and never had to work another day in their life. They think of a high class lifestyle with fancy cars and a Youtube video highlighting your rags to riches story and how you can teach other people to do the same thing. More than likely growth stocks won’t make you rich. We all can’t be the Mark Cuban’s of the world, and it may be a while before we ever see another dot-com era. With all that being said, there is no question that growth stocks still belong in every investor’s portfolio. The key is choosing them correctly.
Let’s go over 3 of the top ways to identify a growth stock that could be a winner. Before we begin, I’d like to point out that growth stocks inherently take on more risk. This is due to the fact that the stocks are typically smaller companies who have not yet reached the status of an income stock. These companies prefer to dump most all profits(or take out more loans) back into the company instead of issuing a dividend. These companies are often losing money or breaking even, and some of the statistical numbers that are key to purchasing a solid income stock may not hold true when looking to purchase a growth stock. Keep that in mind.
#1. The company needs a track record of growth
When investing in growth stocks, you aren’t necessarily picking a fresh company that you believe will be the next big thing. You still need history when picking these stocks. Look for consistently increasing revenue numbers over multiple years. You don’t want to get trapped investing in companies that only talk the talk. You need a sustainable business that has walked the walk. These companies may not be that profitable yet, but their underlying numbers over the course of 5-7 years need to at least say they should get there some day.
#2. Look for operating cash flow, not free
Here is the first fundamental analysis method that differs from income to growth stocks. Typically when you are investing in a dividend stock you would prefer the company have an excess of free cash flow. The main reason for this is this cash flow often ends up in your pocket in the form of dividends. You need to be looking at operating cash flow. A company with a consistently increasing level of operating cash flow is able to expand their operations. Although all of that capital may not be available to issue dividends, you are not worried about this as you are looking for that cash to be re-invested in new projects for the business to increase their value.
#3. Compare the companies growth to its sector
You may have come across a company that you believe is that diamond in the rough you have been looking for. The company has great underlying numbers and is looking like a true winner. Before you purchase the stock, look at the industry as a whole. How volatile is it? How are other companies in the industry performing compared to yours? You may decide that although this stock is a winner, there are multiple other companies in the sector that provide even better potential returns. Due to the fact you may not want to place all your eggs in one basket and purchase them all, you may decide to leave this stock for an even better position.
There are multiple strategies and methods to identifying profitable growth stocks. I could write pages upon pages of strategies and factors you need to take into account. These three are a solid start, and are often the deciding factors when choosing if you would like to look further into a company. Don’t get hung up on one or two underlying numbers being excellent. You need to look at the company as a whole to truly determine if they are worth your hard-earned money. For example, a profitable niche can be thwarted by a bad management team who doesn’t seem to know how to use allocated funds correctly.
Growth stocks tend to take time to grow. But that doesn’t mean once you purchase the stock you are in it for the long haul. If underlying numbers change and your evaluation of the company becomes one that you do not want to be a part of, don’t be afraid to sell. Not every growth stock is a winner, in fact, not a lot of them come to fruition. That doesn’t mean that you are going to lose on the majority of positions you take in a growth stock, it just means they may not be the slam dunk you once projected.
I hope this article has helped you at least get a head start if you are interested in finding some solid growth stocks to add to your portfolio. If you are looking for some solid Canadian growth stocks, check out Stocktrades article on the best growth stocks in Canada for 2017.