Investing in growth stocks could help you fast-track your way to financial independence. However, growth stocks are notoriously difficult to assess. The biggest reason for this is that the hurdles that these companies face could be tough to predict. Whenever a company encounters a hurdle, it could result in a drop in its stock. In this article, I’ll try to shine some light on how I assess growth stocks.
Look for companies that lead important industries
The first thing I check is whether a company leads the industry it operates in. For example, consider Apple and the smartphone industry or Tesla’s leadership position within the electric vehicle industry. A company’s ability to lead an important and emerging industry is reassuring on two fronts. First, it suggests that the industry has lots of room for growth. This would bode well with the companies (and stocks) that operate within it.
Second, it suggests that the company possesses some sort of competitive advantage over its peers. This could occur for many different reasons. For instance, if a company is a first mover in its industry, then it could establish the necessary infrastructure to move past its peers. For example, there are many car manufacturers in the world. However, very few of those legacy car makers are equipped with the infrastructure to mass produce electric vehicles in the same way that Tesla is. Competitive advantages could also lead to pricing power and dominance of the market in the long run.
Does the company exhibit excellent growth?
Next, I look to see whether a company is able to demonstrate above average growth. I tend to look at this from a revenue perspective. Generally, as a company continues to increase its revenue over time, its earnings and stock price should follow in the long run.
To assess a company’s revenue, I look at the last five fiscal years. In the stocks I invest in, I like seeing consistent growth year over year. If a company fails to increase its revenue a certain year, I make sure to figure out what may have caused that decline or stagnation. In addition, I generally hope to see year-over-year revenue growth of at least 20%.
As an added bonus, I tend to target companies that have business models that allow for recurring payments as opposed to large one-time payments. This recurring payment, or subscription-based, business model makes revenue streams a lot more predictable. In today’s market, it seems that more and more companies are trying to shift towards this type of payment plan.
Look at the company’s management team
Finally, I assess a company’s management team. The first thing I look for, in this regard, is whether the company is led by its founder. It’s been previously shown that founder-led companies tend to outperform companies led by non-founders.
I also like to see that the company’s CEO holds a large ownership stake in the company. This suggests that the CEO is willing to be rewarded according to the success of the company. This aligns the CEO’s interests with those of the shareholders. Generally, I want the CEO of hold at least a 5% ownership stake in the growth stocks that I invest in.
