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Share to FacebookShare to TwitterShare to LinkedinClose-up of sign with logo on facade of the regional headquarters of ecommerce company Amazon in the … [+] Silicon Valley town of Sunnyvale, California, October 28, 2018. (Photo by Smith Collection/Gado/Getty Images)

Getty Images Growth investing is the buying of shares in companies experiencing greater revenue and earnings than those experienced by other companies within the same sector or the market as a whole. Growth investing differs from value investing, which is the buying of shares that are trading for less than an investor thinks is their intrinsic value.

A stock can be undervalued for a number of reasons including industry conditions or a public relations fiasco. Such was the case in 2015 when shares of fast-food chain Chipotle dropped by 21.4% after patrons at several of the chain’s restaurants were sickened by E. coli. Chipotle is one of our top stock picks for 2023.

MORE FROM FORBESBest Stocks To Buy For 2023By Catherine Brock Key Principles of Growth Investing The key principles of growth investing are to look for:

Market trends – for example, electric vehicles, cloud computing, and artificial intelligence are hot right now.

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Companies that possess a competitive advantage – for example, e-commerce giant Amazon’s fulfillment and delivery networks, or Tesla’s battery technology. Companies whose market is able to grow – for example, the market for electric vehicles with longer ranges is greater than the market for vehicles having shorter ranges.

Strategies for Growth Investing The best strategies for growth investing have been shown to be:

Following market cycles – during certain periods, growth stocks have been ascendant, while during other periods value stocks have been the top dogs. Growth stocks tend to perform better when interest rates are low because companies can take on debt, which helps them fund their operations. On March 16, 2022, the Federal Reserve made what was the first of eight interest rate increases and this, coupled with sky-high valuations, has caused a sell-off of growth stocks during the first part of 2023. Identifying emerging industries – such as technology and healthcare, or identifying companies that offer innovative products or services. Finding new patents – companies holding patents on new technologies gain a competitive advantage over other companies within their sector. Identifying companies gaining market share – companies gaining share in an existing market such as Nvidia in the graphics card market, or companies that create a new market or industry, such as Coinbase and Airbnb. Staying on top of financial news – new companies are created every day or existing companies begin to be publicly traded. Keeping tabs on growth rates – growth companies display growth rates of 15% per year or higher which means that their stock price has doubled within five years. Watching for high volatility – growth stocks often experience wider price swings than other stocks within their sector; growth stocks rarely pay a dividend preferring instead to plow their profits back into growth, you can learn more about dividend stocks in our “Best Dividend Stocks To Beat Inflation In 2023” article. Investing in growth mutual funds or exchange traded funds (ETFs) – which we discuss below.

MORE FROM FORBESBest Dividend Stocks To Beat Inflation In 2023By Erik Sherman How to Invest in Growth Stocks To identify growth stocks, you’ll need to assess a company’s financials and performance metrics, and analyze its potential for growth. To accomplish that, you’ll need to perform what’s known as quantitative research.

Read a company’s 10-K and 10-Q reports which all companies are required to submit to the SEC. The Form 10-K is filed annually, contains financial information that has been audited by a third party, and includes the company’s balance sheet. The Form 10-Q is filed quarterly, and is a current snapshot of a company’s operations and its finances. To find these reports, go on the SEC’s Electronic Data Gathering, Analysis and Retrieval (EDGAR) website. Visit a company’s investor relations web page which will contain a link to the company’s Annual Report. View companies’ detail pages on any of the free financial websites which include Yahoo Finance, CNBC, Google Finance, MSN Money and Seeking Alpha. Zero in on the important information, especially the price-per-earnings ratio (PE), the earnings-per-share ratio (EPS), and the price-per-sales ratio (P/S). The price-to-sales ratio is calculated by dividing a company’s market capitalization (the number of outstanding shares multiplied by the share price) by the company’s total sales or revenue over the past 12 months; lower P/S ratios are more attractive. The price-per-earnings ratio compares the price of a share with a company’s earnings per share, and this tells investors how much they are paying for each dollar of earnings; TTM is an acronym for “trailing twelve months,” meaning that the figure represents the company’s performance over the past year. Earnings-per-share reflects a company’s profitability and is calculated by dividing a company’s quarterly or annual income minus dividends by the number of outstanding shares; the higher the EPS, the greater a company’s profit and its value.

Below is a list of stocks that analysts have identified as growth stocks, their industry, and their 3-year sales growth:

Tesla (NASDAQ:TSLA) – Automotive – 40% Netflix (NASDAQ:NFLX) – Entertainment – 18% Etsy (NASDAQ:ETSY) – E-commerce – 48% Amazon (NASDAQ:AMZN) – E-commerce and cloud computing – 22% Salesforce.com (NYSE:CRM) – Cloud software – 21% Shopify (NYSE:SHOP) – E-commerce – 52% Alphabet (NASDAQ:GOOG) – Digital advertising – 22%

Another way to invest in growth stocks is to invest in growth mutual funds or exchange traded funds (ETFs). Growth funds are categorized by:

Market cap – the size of the companies included in the fund, such as small-cap, mid-cap, and large-cap. Locality – the locations of the companies comprising the fund, for example, foreign growth funds are comprised of companies based outside of the U.S. Sector – The 13 S&P 500 sectors are: information technology, healthcare, consumer Discretionary, financials, communication services, industrials, consumer staples, energy, real estate, materials, and utilities.

Growth funds that are heavily invested in just one sector, such as technology, can lose value if that sector experiences a downtown. To mitigate that risk, spread your investments over several mutual funds or exchange-traded funds.

The best mutual funds and ETFs for growth are shown below along with with their expense ratios. An expense ratio of 0.05% equates to a charge of $5.00 per year on a $10,000 investment.

Vanguard Growth Index Fund Admiral Shares (VIGAX) – passively tracks the CRSP U.S. Large Cap Growth Index, exposure to 250 stocks – 0.05% Fidelity Blue Chip Growth Fund (FBGRX) – actively managed, tied to the Russell 1000 Growth Index – 0.76% Schwab U.S. Large-Cap Growth Index Fund (SWLGX) – tracks the Russell 1000 Growth Index – 0.035% iShares Russell 1000 Growth ETF (IWF) – tracks the Russell 1000 Growth Index – approximately 500 stocks – 0.18% SPDR Portfolio S&P 500 Growth ETF (SPYG) – tracks the S&P 500 Growth Index 231 stocks – 0.04%.

Pros and Cons of Growth Investing Pros:

High returns – some returns can be eye-popping, when Amazon first began trading in 1997, its shares were priced at $18, due to various stock splits a single share became 12 shares and today, a single share is selling for $116.25, an 11,525% increase. Common good – it is investors who bring new companies, new technologies, and new ideas to market; for example, investors in Tesla are helping to reduce worldwide carbon emissions proving that you can do well by doing good.

Cons:

Timing – the timing of buying and selling growth investments is critical, if you buy on a price upswing and sell close to the peak, all is well, but the price curve can turn down or you may be forced to sell for less than you want. A long time to a profit – a company in a hot growth area can fail to turn a profit for years; Amazon wasn’t in the black until 2003, nine years after its founding and seven years after it became publicly traded. Segment downturns – during the dot.com crash of the early 2000s, investors in online shopping startups and communications companies were left holding the bag when the companies such as Pets.com, Webvan, Worldcom, NorthPoint Communications, and Global Crossing went out of business; while it survived, Cisco lost 80% of its stock value.

Growth Investing FAQs What is the difference between growth and value investing? Growth investing focuses on finding companies with strong growth potential, even if they have a higher valuation. Value investing seeks out companies whose valuations are lower than what an investor thinks they should or can be.

How do I find good growth stocks? Look for companies that have a track record of strong revenue and earnings growth, and a promising future. Pay close attention to trends within sectors and to emerging trends within the market as a whole.

What are the risks of growth investing? Timing, timing, timing; you must properly time your purchase of a growth stock and your sale, and the timing must also be right for the company, its sector, and the market as well.

How much should I allocate to growth stocks in my portfolio? The allocation of growth stocks in your portfolio depends on your investment goals and your tolerance for risk. It’s generally recommended to diversify your investments across different asset classes, including growth, value, and income stocks.