7 questions before buying growth stock

Feeling up for a bumpy and risky ride that could make you extremely rich? Are you an adrenaline junkie disguised as an investor? Then growth stocks may be what you’re looking for.

Contrary to value investing, which looks for established companies to hold long term, with good financials at undervalued prices.

Growth investors look for companies which even though they have not yet seen massive revenues and profits, they believe will in the near future.

They are willing to buy stocks at something that a value investor would call overpriced, because of hope in future explosive profit growth. This leads, if you get it right, to an increase in the stocks price, making the price it was bought at, undervalued.

In simple terms, value investors look for value, growth investors look for future value.

Good growth investors are not speculators. They don’t bump all of their money in a random stock which caught their eye. There’s a whole set of criteria followed, which different from value investing. So without further delay here’s the 7 questions to ask yourself before buying a growth stock.

1.   Is the market expanding?

Although it is more of a suggestion than a rule, you are looking for a company with at least a 10% revenue growth per year. That’s impossible to pull off if you’re not focusing on an expanding and large target market.

Successful growth companies often start by becoming a leader in a specific niche and only when already profitable moving out to the broader market space.

Think of Amazon, which started by selling books online and has now expanded in all possible markets, becoming one of the biggest companies in the world.

2.   Does it have a MOAT?

Just like in value investing, the company you’re looking at has to have something stopping competitors from taking its place, a competitive advantage. Just like in a medieval castle the moat. 

It has to be able to grow a lot, undisturbed, for a prolonged period of time. There’s 4 main types of competitive advantage. Ideally the company should have all of them.

a) Network effect
The business becomes more valuable when it has more clients that will spread the word. Such as an online marketplace.

b) Intangible assets
An intangible asset is an intellectual property or simply the brand image which cannot be copied by competitors. Gaining an advantage they lack. An example is KFCs secret formula or Apple’s logo.

c) High switching costs
A customer won’t switch products because it would be too difficult or expensive to do so and just wouldn’t be worth it. Just look at your local grocery store. You aren’t willing to change it because it would be inconvenient and it would take 5 minutes more to get there.

d) Low cost producer
The company should be able to produce and charge their products at a lot less than the competition, without sacrificing quality. Walmart has built an empire this way.

3. Does it have great leadership?

The CEO and all the management team have to be on board with the mission. Believe in the project and do whatever it takes to see it succeed. A strong and competent CEO and management team will increase investors’ trust in the company and make it grow more.

Elon Musk head of Tesla, Mark Zuckemberg from Facebook and Jeff Bezos CEO of Amazon are 3 great examples of this.

4. Does it have momentum?

Great growth companies stock prices are pumped up by hyped investors. This is best achieved by having a grand mission and constantly moving towards it, by beating market expectations and selling themselves right. Tesla is a great example of this, it just won’t stop winning. People love that.

5. Can it bear the financial weight?

Now, with growth stocks you aren’t looking for companies with low debt and high cash flows. It’s simply unrealistic, growth companies at the beginning reinvest all that they earn back in the business, so as to establish themselves in the market.

 Hopefully they are able to sustain themselves by producing enough cash flow, but that’s not often. What it has to be able to do is earn the trust of banks and creditors so to allow them to continue operating, by building debt. Hopefully the company uses the debt to establish itself in the market and become profitable skyrocketing the valuation. This would increase cash flows that would eventually, ideally, pay off the debt.

6. How’s the corporate culture?

The dream and ideal the company is founded and is striving for should trickle down to the employees. So to make them more motivated to work for them and become more productive.

You don’t want to see a company which can’t hold on to key employees, losing them to competitors. Great indicators of corporate culture like the employees’ acceptance of the CEO can be found on sites like Glassdoor.

7. What’s the business model?

Most successful growth companies create business models aimed at keeping customers coming back. Finding new customers everytime is a lot more difficult than selling products to existing customers, already familiar with your brand and company identity.

A great example of such a company is Starbucks. Everyone keeps coming back for coffee- Some twice or even three times a day. They know their customers and market to them keeping them engaged and hooked to those sugar fields, caffeine rich, beautiful Frappes.

Keep in mind that this is not a hard rule, theirs great companies like Tesla who cannot in any way aim at this. It’s kind of difficult to convince people to buy a new car a week.

Before you go for it…

Keep in mind that investing in growth stocks can either make you a lot of money or fail miserably and spectacularly losing all you invested. So make sure you have thought about it well, know what you’re and what you are investing in. Make sure to compare the benefits and the risks and try to follow the golden rule. Don’t lose money.

Disclaimer: The Content is an opinion and is for information purposes only. It is not intended to be investment or financial advice nor does it constitute an offer to buy or sell or a solicitation of an offer to buy or sell shares or any other assets. Seek a duly licensed professional for investment or financial advice.