Breaking Down Safe Growth Investing

Growth investing: a catchy name you hear at cocktail parties. But do you really know what it means?

In most circles, it refers to buying into companies (through equities, partnerships, etc.) that show signs of "above average growth".

At first glance, this looks good; a company that is growing quickly should have a rising share price, and be a good place to park your money.

But what is above-average growth? Is it number of employees, square footage, number of products, profits? And what data is used to calculate the average?

What is Growth Investing?

Let's break it down:

"Growth" usually describes the type of asset/investment you're looking to purchase. In this case, we're talking about stocks with above average growth.
"Investing" is the decision making process for improving your finances

Now let's put it all back together: growth investing is the decision-making process you use to buy shares in companies with above-average growth in their financial metrics.

Here are a few examples of "above-average growth":

"Substantial and sustainable" positive cash flow
Predicted revenues increase "faster" than competitors
Predicted earnings increase "faster" than competitors

The words in quotations are meant to call your attention to the fact that even these criteria are subjective; "substantial and sustainable" can vary from industry to industry, market to market.

Growth Investing Criteria

If growth investing is part of your strategy, you'll want to buy investments that grow the account sizes in your personal balance sheet. In other words, you want to buy some rocket ships. Stocks that meet the criteria outlined below will do just that:

High Growth
Low Supply
High Demand
Positive market conditions

You can find this information in many places, so feel free to use whatever source is easiest for you. For starters, try Finviz.com.

Instead of the stocks you hear about on CNBC, watch the action of the market leaders you discover, as they often lead the general markets higher and lower.

High Growth (Increasing Earnings per Share)

"Earnings per share" (EPS) is a company's after-tax profit divided by the number of common shares outstanding. EPS is usually reported on a quarterly and annual basis.

In order to be considered a candidate for your watch list:

1) The current quarter's earnings should show a major increase over last years earnings in the same quarter (>20%).

For example, the 1st quarter EPS in 2014 should be compared with the 1st quarter EPS in 2013, NOT the 4th quarter of 2013.

2) The current quarter's earnings should be higher than the previous quarter's earnings, for the past 10 quarters (accelerating).

If you find two quarters of decelerating growth in EPS, consider that a negative (sell) sign.

3) Annual earnings per share should be growing year over year for the last 5 years (>25% increases) If you're calculating after-tax profit by hand, watch out for "nonrecurring earnings". Nonrecurring earnings are not counted towards EPS because they are one time events (such as the sale of land).

Low Supply (Number of Outstanding shares)

When a small number of shares are available, the concept of supply and demand takes hold. If demand is higher than supply, prices will rise. Secondly, the number of shares traded per day/week (i.e. volume) should increase as the stock moves up in price. Therefore, the lower the number of outstanding shares, the better.

High Demand (Level of Institutional/Insider Ownership)

Look for stocks that have been purchased by institutional investors. Ideally, you're looking for name-brand institutional investors, with a reputation and track record of high returns.

Increasing institutional ownership means more awareness of a stock by the large players. Since you and I are not market makers, our biggest gains come when large players initiate and add to their positions.

Positive Market Conditions

You've heard the sayings: "even turkeys can fly in a windstorm" or "a rising tide lifts all ships". Basically, it means that all kinds of stocks will rise if the general markets rises. A rising market makes experts of us all..and a falling stock market usually makes fools of us all too!

The general market has a HUGE impact on the price performance of stocks. If you're not disciplined, it can have an equally huge impact on the performance of your investing strategy.

Study the market indexes every day for price and volume changes to figure out what the trend (uptrend, flat, downtrend).

A general rule of thumb is that 3/4 of all stocks will rise and fall with the general market.

But since we're looking for high growth companies, we need to be extra vigilant with our trading rules. These high performance stocks usually move 2-3x the market change. So if the market is falls 1%, your growth stocks will be down 2% to 3%.

This illustrates another reason why cutting your loses is so important. A 5% correction market prices could result in a 10%-15% loss in the value of your stock!

Your Next Steps

It goes without saying that these are guidelines. You'll always find companies that do not fit these criteria and still provide rapid growth. And you'll always find companies that fit the criteria, and then watch as their stock price falls off a cliff.

Think of these criteria as a way to increase your odds of success, with the knowledge that you still need a plan of attack, to practice sound trading money management, position sizing, and diversification.

If you're interested in learning more about the relationship between price and volume, or how to find and trade the best stocks for your growth strategy, check out this book on Amazon via the following affiliate link:

How to Make Money in Stocks: A Winning System in Good Times and Bad.

It's one of my favorites.