Hello, InvestorPlace Readers! This is the first installment of our new “How to Invest” series. We’ll be covering investment opportunities ranging from growth stocks (see below) to electric vehicles to SPAC IPOs and much more. If you’re interested in a particular sector, please drop us a note to make a suggestion: email@example.com.
If you’ll permit me to make an over-simplification, then I would tell you that there are two types of investors in the world: Those who buy value (to add small gains over long periods of time) and those who invest in growth (to add large gains in relatively shorter amounts of time).
The value investors were right, for a time. Since 1926, value has returned 1,344,600% to growth’s 626,600%, after all … but you’ll soon understand why those figures are misleading to investors in 2021.
The kinds of stocks that passed for “growth” in 1926 and subsequent decades are not exactly the kinds of stocks we associate with growth in the modern age.
Instead, what if I told you that growth stocks have absolutely crushed value stocks for the past 10 years?
In fact, growth has outperformed value in every single year since 2011, except for in 2016. But the growth trade more than made up its underperformance by trouncing value by a then-record 11.9%.
Still straddling that fence? Need to do more due diligence? We’ve got you covered.
What follows is our crash course on growth stocks, where you can learn everything there is to know about growth investing, including my simple strategy for identifying hypergrowth winners no matter the market conditions.
But first, we have to start where all good crash courses start, and that is with a definition.
What Are Growth Stocks?
A growth stock, as the name implies, is a stock of a company that is growing faster than average.
The accepted measures of “fast” and “average,” however, can vary wildly. To outperform the market, you have to beat the S&P 500. And 4% growth, which the S&P averaged over the past 10 years, isn’t exactly warp speed.
And individuals need more than that. For a single investor with a small portfolio, the difference between beating the market or not often comes down to a single stock going parabolic. It’s the stocks that go up 100x that will blow the doors off your portfolio.
That means investors looking at high-growth areas such as tech still need to choose superstars in the sector. Even if a tech stock is growing at 10%, it’s not a growth stock unless it’s outperforming its tech peers.
It’s why most investors think of growth in terms of individual sectors, and not the entire market.
You want to find a growth stock in the tech industry? Find one like Facebook (NASDAQ:FB), with its 20%-plus revenue growth. Or find an Amazon (NASDAQ:AMZN), a Netflix (NASDAQ:NFLX), an Alphabet (NASDAQ:GOOGL, NASDAQ:GOOG), etc.
The bottom line: Look for companies whose revenue growth beats their sector-benchmarks and not just the S&P’s.
Characteristics of Growth Stocks
Beyond growing quickly, all growth stocks share five common characteristics:
- Secular growth market exposure. A rising tide lifts all boats. And technological changes from the internet to biotech has created multi-billion-dollar industries like Facebook and Amazon in its wake.
- Industry leadership. The best growth stocks don’t just operate in high-growth markets — they are often the leaders in those high-growth markets. Again, see Facebook and Amazon. Facebook is the leader in the high-growth digital advertising space, while Amazon is the leader in the high-growth e-commerce market.
- Great products/services. Revenue is a function of demand. So, for growth companies to sustain better-than-normal revenue growth, they need to continually drum up better-than-normal demand for their products and services. Often, that ability comes from the quality of the product or service that the company is selling.
- Tons of innovation. Innovation is the most underrated fuel for growth. The more a company innovates to either create new products, or launch new marketing campaigns, or expand into new markets, the faster that company will grow.
- Steeper-than-normal valuation. Not all common characteristics of growth stocks are good characteristics. One common “bad” characteristic is that growth stocks tend to feature richer valuations than your average stock, i.e. they have bigger price-earnings or price-sales multiples. That’s simply because investors are willing to “pay up” for bigger growth. And because the bulk of value of a growth stock lies not in what the company is today, but rather what it can be tomorrow.
It Only Takes One Growth Stock to Succeed
Keep in mind, not every stock that has these characteristics will succeed. Luck plays a strong role as well — few expected a plucky Harvard student creating Facebook to unseat MySpace, the innovative leader in its industry with a growing valuation and great products.
The great thing about growth stocks, though, is that you only need a couple bets to succeed.
In a portfolio of fifteen stocks, having one or two turn into the next Amazon is all it takes to 10X your investment.
Most people don’t realize it, but there are incredible money-making opportunities all around us! Living in America is like living in a money booth, with millions of dollars blowing around you all of the time … you don’t have to catch them all … you just need to catch one million-dollar opportunity.
Most of us don’t see it. We aren’t trained to spot these opportunities, even when they’re right in front of our faces.
Fortunately, you don’t need an MBA to train yourself to spot the winners. You don’t even need to be an expert in the sector where you’re chasing the 10X winners. You simply need to keep your eyes open to the opportunities that are around you right now.
Think about it … a lot of folks were using Netflix back in 2012. And if they had invested back then, they would have made more than 4,000%. Because when you go from a small startup to creating value for more than 100 million subscribers, your stock tends to soar.
Then there’s Ulta Beauty (NASDAQ:ULTA), which was a largely unknown makeup and health product retailer in 2009. But over the next decade or so, Ulta’s unique in-store experience made Americans go wild … and Ulta’s stock soared an incredible 50X in response.
And, of course, there’s Amazon, the “granddaddy” of consumer hits.
As Jeff Bezos puts it in his transition letter, the highest compliment one can pay an innovator is with a “yawn.” And certainly Amazon has innovated so much that it’s become commonplace — meaning everyone just expects it.
But it took a lot for AMZN to go from selling books to selling nearly everything. And its success has driven massive gains in its stock. Which is why Amazon shares increased more than 100-fold from 2003 to 2018.
It’s basically a one-stock retirement shop.
The point is, you didn’t need anything fanciful to spot these opportunities. You just need to be paying attention to the innovative leaders in fast-moving megatrends.
How to Pick the Right Growth Stocks
Now that you understand what a growth stock is and what it looks like, you are ready to answer the most important question of this crash course: How do you pick the right growth stocks to invest in?
There is no universal “right way” to pick winning growth stocks.
But, in my years as a growth stock investor and analyst, I have devised a formula that I find particularly helpful when investing in growth stocks.
It’s a pretty simple process that involves two elementary steps:
- Identify investment megatrends that are unstoppable and will redefine how the world works.
- Within those megatrends, find the most relentlessly innovative companies that will dominate the megatrend at scale.
Megatrends? Innovation? What does all that mean? Let’s break it down.
Investing in Megatrends
Step one: Identify investment megatrends that are unstoppable and will redefine how the world works.
Think about the rise of e-commerce … the shift toward digital advertising … or the spread of mobile phones.
These are investment megatrends that redefined how the world worked over the past two decades. The path wasn’t always smooth. Between 2000 and 2020, it seemed like the world has stumbled from one crisis to the next.
Yet, through it all, global e-commerce sales rose by 1,269% from 2000 to 2020. North America digital ad sales rose by 1,954%. Mobile phone sales rose by 406%.
Sure, these megatrends were slowed somewhat by external noise. But not stopped. And that’s the whole point. By investing in secular megatrends, you are investing in unstoppable forces.
To be a successful growth stock investor, you need to identify these unstoppable forces at early stages. You need to invest in emerging megatrends before anyone else, so that you can get in on the ground floor of the world’s biggest investment opportunities.
What are some of the megatrends that I’m most excited about today?
Self-driving. Gene editing. Space exploration. Plant foods. Online sports betting. Influencer marketing. Streaming TV. Solar energy. Hydrogen power. Artificial intelligence. Big data. And more.
But investing in a megatrend alone doesn’t make you a great growth stock investor. No. You need to go one step further and separate the wheat from the chaff in that megatrend to be a good growth stock investor. It’s the difference between landing with the next Amazon.com winner or a Pets.com flop.
And that’s where step two comes into play.
Investing in Innovation
Source: Olivier Le Moal / Shutterstock.com
Step two: Find the most relentlessly innovative companies that will dominate the megatrend at scale.
Emerging megatrends tend to attract new companies by the boatload, and being part of a megatrend isn’t enough to make a growth stock a long-term success. Indeed, most companies in emerging megatrends end up going bust — just look at the dot-com bubble!
You see, emerging megatrends eventually and inevitably grow up and mature. As they do, the markets consolidate around a few very strong players. The rest gets squeezed out of the market.
So, if you want to be a great growth stock investor, it’s not enough to just identify investment megatrends.
You have to identify the best companies in that megatrend – and how do you do that?
By finding the most innovative companies in the space, because innovation enables companies to sustain big growth, develop competitive advantages and turn into market leaders. Among these growth stocks, you just may find the next Amazon, the next Facebook or the next Apple.
Big picture: by investing in the most innovative companies in the most promising hypergrowth megatrends, you will put yourself in a great position to be a great growth stock investor.
Value Stocks vs. Growth Stocks
If you’ve gotten this far, you’re now equipped with the know-how to invest like a professional growth stock investor. But does that mean you should go out and buy a bunch of growth stocks right now?
Not necessarily. Allow me to explain …
This debate has many moving parts, and can oftentimes get quite complex. But, at a fundamental level, it all boils down to one thing: The cost of equity.
Understanding the Cost of Equity
The cost of equity takes on many definitions. But with respect to this discussion, the cost of equity wears the hat of “the required rate of return on an investment in equity.”
It’s basically the annual rate of return you would require as an investor to be invested in a stock. There are many puts and takes in arriving at that required rate of return, but according to the Capital Asset Pricing Model (CAPM), it can be calculated as follows: Cost of Equity = Risk-Free Rate + Equity Risk Premium.
Where the risk-free rate acts as a proxy of the return you could get by investing in a risk-free instrument (like a Treasury note) and the equity risk premium is the additional return you require for taking on the risk of investing in a stock (that isn’t guaranteed to go up).
The cost of equity, therefore, oscillates with interest rates and perceived economic health.
When interest rates are high and perceived economic health is low, the risk-free rate is high and the equity risk premium is high, resulting in a high cost of equity.
On the flip-side, when interest rates are low and perceived economic health is high, the risk-free rate is low and the equity risk premium is low, resulting in a low cost of equity.
This matters because the cost of equity drives stock prices. When it’s high, the present carries more value than the future, and value stocks tend to outperform. When it’s low, the future carries more value, and growth stocks outperform.
It’s as simple as that: Buy growth stocks when the cost of equity is low, avoid them when it’s high.
How Technological Change Propels Growth Stocks
Of course, the cost of equity isn’t the only determinant when it comes to whether you should invest in growth stocks.
Technological change matters, too — and perhaps much more than the cost of equity even.
The world is not static. It is dynamic. Every year — every month, even — old technologies fall by the wayside, and are replaced by new technologies. Companies aligned with those new technologies, obviously, grow quickly, and turn into growth stocks. Companies aligned with the old technologies fail to grow, and turn into value stocks.
Thus, the pace of technological change matters to growth stock investors. When the pace of technological change is fast, growth stocks will grow more quickly and likely outperform. On the flipside, when the pace of technological change is slow, growth stocks will grow less quickly and likely underperform.
With that said, I’d like to introduce you to a concept that implies the pace of technological change will never be slow again: The law of accelerating returns.
What Is the Law of Accelerating Returns?
At its core, the law of accelerating returns is the idea that technological change isn’t linear — it’s exponential. That is, the rate at which technology changes, actually accelerates over time. For example, technology changes faster today than it did in 2000, and it changed faster in 2000 than it did in 1950.
Futurist Ray Kurzweil first coined the term in 1999. At the time, he was simultaneously inspired and awed by the fact that, in just a few dozen years, U.S. corporations transformed the concept of a computer into a mainstream, widely adopted consumer product. He was similarly enthralled by the internet — which was essentially a science fiction concept in the 1970s — and how one out of every two Americans were using the technology by the turn of the century.
After all, it took humans thousands of years to figure out the wheel, stone tools and fire. Turning computers and the internet into a reality in roughly thirty years was a landmark accomplishment.
And yet, by modern standards, that’s almost slow.
The 21st Century has been marked by an unprecedented acceleration in technological change. The iPhone wasn’t a thing until 2007. Nor was streaming television or cloud computing. Today, less than 15 years later, everyone has an iPhone, every household subscribes to a streaming service and every enterprise is on the cloud.
And, the craziest part is that this is just the tip of the iceberg. This acceleration in technological change will only continue over the next decade and beyond. As it does, growth companies aligned with technological change will likely only grow more quickly — which, of course, has positive implications for growth stocks.
You Have to Ignore the Noise in Growth Stock Investing
You feel ready now, huh?
You know all about growth stocks and what makes them tick. You know how to find the best growth stocks, when to buy them and when to sell them …
Certainly, you’re ready to go out there and start investing, right?
Just one more thing. Arguably, this is the most important thing when it comes to investing in growth stocks. You have to ignore the noise.
Let’s go back to our rationale for why we invest in megatrends.
We noted how megatrends like the rise of e-commerce, the shift toward digital advertising and the spread of mobile phones survived multiple economic and social crises throughout the 2000s and 2010s. Crises such as the dot-com bubble, the 9/11 attacks, the Iraq War, the Great Financial Crisis, a U.S.-China trade war, a global pandemic and much more.
Yet, each time every one of those crises emerged, waves of investors sold e-commerce stocks, digital ad stocks and mobile phone stocks. Amazon stock crashed during the dot-com bubble. Apple stock plummeted during the Great Financial Crisis. Facebook stock was crushed on the heels of the Covid-19 outbreak.
Where do all those stocks trade now? Significantly higher than where they traded even before they crashed.
See the point?
Every time a major economic or social crisis emerges, investors are tempted to sell everything … even growth stocks. It’s human instinct. Sell first, ask questions later. Yet, growth stock investors almost always regret selling their growth stocks when crises emerge, because a few years down the line, those stocks end up trading multiples higher than where they were pre-crash.
Thus, to be a successful growth stock investor, learn to ignore the noise and keep your eyes on the prize. It’s the only way you will be able to secure consistently large returns over a long time horizon.
The Impact of Growth Stocks
Phew. That was a mouthful, huh?
Hopefully now you understand growth stocks. What they are. How they work. How to pick them. When to buy them. And how to be successful when investing in them.
But here’s one final piece of advice: As you’re looking for high-growth stocks to buy, steer far clear from the bluster and stay focused on the big picture.
You’re looking for innovative leaders in emerging megatrends, and getting on the right side of these trends is all you need to know to make big returns.
Let’s go back to the 1990s for an example …
Two revolutionary technologies managed to achieve widespread adoption. In the process, they reshaped the world and led a historic economic boom. But a campaign of fear, uncertainty and doubt among the talking heads on TV could have prevented investors from buying into these revolutionary technologies.
I’m talking about personal computers and the World Wide Web … could you imagine if investors stayed away from these types of companies?
The benchmark technology stock index, the Nasdaq, gained 40% in 1995 … then 22.7% in 1996 … then 21.6% in 1997 … 39.8% in 1998 … and then an incredible 85.6% in 1999.
Annual gains of 1,000% were common in the tech sector. Literally, if all you knew about investing in the ‘90s was that personal computers and the internet would lead to a productivity boom, you could have made a fortune.
Of course, the dot-com bubble deflated the value of a lot of internet companies, but it also gave us Amazon, which has since gone from mere book-seller to purveyor of pretty much anything and everything.
From its initial public offering (IPO) in 1997 through mid-2020, Amazon’s value increased more than 160,000%. That’s enough to turn every $10,000 invested into $16 million. And it’s certainly more than enough to outperform the S&P 500.
See More: How To Invest
On the date of publication, Luke Lango did not have (either directly or indirectly) any positions in the securities mentioned in this article.
By uncovering early investments in hypergrowth industries, Luke Lango puts you on the ground-floor of world-changing megatrends. It’s how his Daily 10X Report has averaged up to a ridiculous 100% return across all recommendations since launching last May. Click here to see how he does it.