What are growth stocks?
Stocks are known as growth stocks when they significantly outperform the wider market in terms of share price growth. They are unlikely to pay dividends, preferring to plough any earnings back into the growth of the business, but they aren’t always small, new companies.
Picking growth stocks sounds easy enough. But when it comes to spotting the best growth stocks to invest in, there will always be a multitude of opinions.
Do you look at last year’s success stories, and pick fast—growing stars like estate agent Purplebricks, online takeaway Just Eat, and fashion retailer Boohoo? All three are online market disrupters, though in different sectors, chipping away at established players, suggesting a theme that investors might follow.
According to broker Peel Hunt, all those stocks could continue to deliver impressive growth in 2018. The broker was unfazed by the strong 2017 performance of their top picks, insisting there was more to come.
Among other familiar brands on its 34—strong growth list were homestore B&M, landscaping firm Marshalls, comparison site Go Compare, property site Zoopla, and fashion retailer ASOS.
Past performance is no guarantee of the future
The share tipped for the fastest growth in 2018 was Nostrum Oil & Gas, a minnow in a sector which has been overlooked for years but has been boosted by the oil price rally. At the time of writing Nostrum was 33% down in 2018, a reminder that small companies – and forecasts about them – are risky. And that’s why picking growth stocks is tricky. Past performance is no predictor of the future.
It’s the biggest fish that may yet become supersized, according to three seasoned private investors asked this year by the Motley Fool website. Asked to pick the stock that they could hold for 50 years, they named Apple, Paycom Software, and Johnson & Johnson.
Legendary investor Warren Buffett has bought 75 million Apple shares this year, adding to the 165 million he already holds. What’s his logic?
‘Nobody buys a farm based on whether they think it's going to rain next year or not,’ Buffett said. ‘They buy it because they think it's a good investment over 10 or 20 years'.
The company raised its last quarterly dividend by 16%, funded by less than a quarter of profits, and announced a new $100 billion share buyback which could boost the share price further. In May that it was priced at 18 times earnings – lower than the 25 times average of the S&P 500.
Paycom Software, however, was priced at almost 100 times earnings, which for many would highlight the importance of the investing strategy known as growth at the right price (GARP).
Johnson & Johnson meanwhile, was picked out as a healthcare behemoth with a well—diversified business, a history of growing the dividend, and a reputation as the ‘ultimate defensive stock’.
A typical high—flier which divides opinion is Tesla. Shares in the electric car maker plunged by more than 25% in March 2018 due to concerns about sales, and are almost 30% off the peak hit in June 2017 — a reminder that buying a high—flying growth stock is easy, but holding onto it for the long term is harder.
Investing in growth stock funds
You could trust someone else to pick your growth stocks, like the managers at Scottish Mortgage investment trust for instance. The global fund has delivered a 330% total return in the decade since the financial crash, has grown from £5 billion to £7 billion since joining the FTSE 100 stock index last year. It has a portfolio packed with US and Chinese technology stocks, can invest up to 25% of the portfolio in unlisted stocks, and part of its strategy of getting in to the big stories early. But surely it’s too late to buy this kind of fund now, after such a long bull market?
Not at all, says co—manager Tom Slater. He says Amazon, almost 9% of the trust, may be up 370% over five years but it has only 2% of the US retail market, while its Chinese equivalents Tencent and Alibaba have the ‘amazing tailwind’ of a consumer market growing at 10% a year. The trust is also a great champion of Tesla, its fourth biggest holding.
Edinburgh Worldwide investment trust, also in the Baillie Gifford stable, operates the same strategy only with small companies — those who may grow into tomorrow’s tech titans.
Smaller company funds traditionally outperform the mainstream. For instance, the Standard Life UK Smaller Companies investment company looks for businesses in the mid—phase of growth, and its portfolio has a price to earnings (PE) ratio around 30% higher than the market average.
Also looking for the hidden growth gems are private equity investment trusts. Those operating a ‘fund of funds’ strategy enabling them to sample different portfolios include Standard Life Private Equity, Pantheon International and HarbourVest Global Private Equity. The best time to buy is when they are trading at above—average discounts to asset value.
Growth stock ETFs
Investment trusts can be cheap (Scottish Mortgage costs 0.37%), but if you believe all managers are too expensive, there is a wide choice of exchange traded funds (ETFs) for the growth investor.
The iShares Russell 1000 (or 2000) Growth and the Vanguard Growth (or Mid—Cap Growth) are among 45 US—listed ETFs tracking growth, while the iShares DJ Euro STOXX Growth Fund (IDJG) is listed on the London Stock Exchange (LSE). There are also five private equity ETFs listed in the US and one in the UK, the iShares S&P Listed Private Equity Fund (IPRV).
You can find growth ETFs using IG’s ETF screener.