Small caps growth investing strategy

August 5, 2019 / Investment Ideas

What does Growth Investing mean?

When people talk about a growth stocks investment strategy for their portfolio what does that mean? First of all, most people think of technology start-ups when they think of growth investing. This is logical, since these are the types of companies the media covers. Usually you read about an  incredible initial public offering, or an acquisition of a small technology company and the early investors get very rich. Although this is exciting news it is not what growth investing is about.

No one is able to predict the future value of a company.  As a result, all stock prices fluctuate based on changes in expected value. This is especially true for smaller companies. Such growth equities are known as small caps. In summary, growth investing is a more volatile investment strategy whereby you purchase equities  based on their expected future value.

In a formula:

Present Value   x   Growth Rate  =   Future Value

The present value is the current share price, which when multiplied by the assumed rate of growth gives the estimated the future value.

Why does Growth Investing perform better?

Firstly, small caps have potential for huge returns, despite a bigger potential for loss, if the business does not perform as well as expected.

Secondly, analysts don’t cover many many smaller stocks. Large institutions, such as pension funds, don’t consider small stocks because they generally only invest in large, well-researched companies. Consequently, lower demand and trading volume can lead to pricing inefficiencies. Consequently, sometimes you can buy small company equities very cheap. Over time, small cap equities beat large cap equities because they are unknown to the general public. These are equities which double, triple, even quadruple in value for an investor over the years. With growth equities, this happens all the time. In fact, all most every great large cap equity was originally a small cap equity.

Should I invest all my capital into Growth stocks?

If you can make such huge profits with a growth stocks portfolio, does this mean your investment strategy should be 100% growth equities? No, growth investing should only make up a smaller part of your overall portfolio. The reason for this is simple: the potential for huge growth also means there is potential for huge losses. We can all identify good investments in hindsight, but it is much harder to identify which small caps will make you rich. In short, the key to growth investing is to diversify holdings between good small cap equities purchased at good prices. If you don’t want to concentrate on a few stocks buy an ETF instead. Never invest more than your risk tolerance.