Some of the biggest names in investing have been dedicated growth-stock investors. These investors believe that they can outperform their peers and the market by investing in companies that will grow market share and earnings more rapidly than competitors; often, these companies are small since small companies are able to achieve higher growth rates relative to large companies.
This strategy, broadly called growth investing, is pursued because the manager believes that faster-growing stocks will achieve higher returns than slower-growing stocks.
This style of investing is very popular in large part because of the incredible gains that come from investing in successful, high-growth companies; in fact, it is not uncommon to hear about long-term growth stocks that increase over 1,000% (now famously termed a “tenbagger” by Peter Lynch).
Growth investors also see evidence of great performance from famous and successful mutual fund managers, such as Peter Lynch, one of the most famous growth-oriented mutual funds managers, who writes about his numerous successful and unsuccessful investments in his book One Up On Wall Street.
Another famous growth investor was T. Rowe Price, who launched his first fund in 1950. This fund, the T. Rowe Price Growth Stock fund, paved the way for Price to build one of the largest mutual fund companies in the United States.
In fact, the two largest actively-managed mutual funds in the United States are both growth stock mutual funds: the American Funds Growth Fund of America (AGTHX – $160 billion), and the Fidelity Contrafund (FCNTX – $80 billion).
So with all the hype about growth investing, how can you find a good growth fund? The most important thing is to find a growth-based fund with a long history of successful performance. Of course, past performance is no guarantee or predictor of future performance.
One easy route is to find and compare growth-based funds and fund families that promote the growth-based approach. For example, all three of the Primecap Odyssey mutual funds are categorized as growth funds.
Another approach may be to compare a mutual fund’s statistics and multiples to the average market multiple to see if the manager has a growth orientation. Two telling signs of a growth investor are high Price-to-Earnings ratios and high Earnings growth rate.
The Price-to-Earnings (P/E) multiple expresses the relationship between the market price of a stock relative to the Earnings Per Share. A high P/E stock implies that investors are willing to pay high prices relative to the company’s earnings; this is because growth investors will expect these earnings to grow quickly.
This assumption should also be reflected in the average Earnings growth rate of the portfolio. Growth investors typically invest in companies that are growing earnings faster than the market average, so the growth rate of the earnings in a growth mutual fund should be higher than the average growth rate for the whole market.
Many fortunes have been made in growth stock investing. By finding a growth-oriented mutual fund manager you trust who has a history of successful growth investing, you may be able to give your portfolio the edge it needs to beat the market.