Here’s how I find the best FTSE growth stocks

Jabran Khan details how he goes about identifying the best FTSE growth stocks for his portfolio using certain criteria he has identified.

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I look for two types of FTSE shares to invest in for my portfolio. I am looking to make the maximum returns possible through dividend and growth stocks.

Although I keep an eye on developments across worldwide markets, I feel most comfortable looking for growth stocks on the FTSE 100 index, personally, as this is where the majority of my investing experience lies. Some of my examples here are not on the FTSE but they are well known and help paint a clearer picture. 

Dividend stocks are established companies with a long-standing reputation of paying out a regular dividend. Growth stocks have a bit more risk attached, as they are sometimes less established but have the potential to offer attractive capital returns in the long term.

What is a growth stock company?

Growth stocks companies are expected to perform at an above-average rate when compared to their wider respective market. These firms usually have some form of competitive advantage that will justify this potential.

A growth stock can also be any firm that has the capability to expand in the future. This expansion could be via a new product or attempting to break into an untried market or offering a high end service that sets them apart from others. Examples of such companies include Apple and Tesla.

One example of an established stock away from the FTSE that I think could still be considered a growth stock is Amazon. Its initial public offering (IPO) was back in 1997. Back then, the online marketplace was very much in its infancy. Amazon was an original idea and an interesting opportunity. I believe it is one of the most fascinating growth stock stories of recent times. Amazon continues to bring new ideas to the fore and therefore its growth can be expected to continue.

When reviewing FTSE stocks for my portfolio, I look for firms that I believe will perform well in the future and, in turn, allow me to make an attractive return.

Reviewing the financials

There is no magic formula or equation related to how I pick stocks for my portfolio. I have a simple set of criteria and characteristics that I review. The majority of my method involves research and due diligence.

1. EPS. I believe one of the most notable characteristics of growth stocks is a high earnings per share (EPS). This indicates to me that profits are increasing at a faster rate than the market average. Using Amazon again, its EPS for the 12 months ending 30 June 2021 was $57.43. This is a 120% increase year-on-year. Of course, Amazon is a rare phenomenon — it is rare for stable and established firms to match this level of growth. I would love to find a FTSE growth stock with a similar EPS, and will continue to review the market.

2. P/E. A high price-to-earnings (P/E) ratio is another growth stock characteristic. The P/E ratio measures the value of a firm in relation to its EPS. A high P/E ratio often indicates more expensive growth. Netflix, for example, has a P/E ratio of 57, which is high. In comparison, the P/E ratio of the FTSE 100 average stands at 13. The higher value of growth stocks is often derived from expectations that the company will deliver growth in the future. Personally, I think Netflix is too expensive now as the streaming market has become more saturated since the pandemic began. 

3. Debt. I often find newer growth stocks have unstable financials. This means their financial records may be a bit spotty because they have yet to achieve full potential. I find that these growth stocks often reinvest earnings into research and development as well as expansion. Using Netflix again, it borrowed over $16bn in the past decade as it did not make enough to meet the costs of making more content and general expenses. In January 2021, Netflix reported it would no longer need to borrow money, and could pay back existing loans. This would be good news to me as a potential investor. In simpler terms, growth stock may have volatile financials and that shouldn’t put me off, as it is often the case for growth stocks.

Other aspects I consider in my FTSE picks

One of the first signs I look for in any of my picks is a competitive edge, such as a unique product or service, or a patented technology. Any of these can offer a firm a significant boost to the value of its shares. Sometimes ideas that have not yet taken over the market may be a competitive edge. One example that springs to mind here is social media giant Facebook. Despite other social media firms being active at the time of Facebook’s inception, its unique offering and unique selling points, catapulted it atop a burgeoning industry which is now part of the fabric of everyday life.

Another aspect to consider is that growth stocks could differentiate themselves by being able to deliver low-cost products compared to the rest of the market. IKEA, for example, with its ready-to-assemble furniture model, had a newer efficient method of production. Finally, sometimes simple things such as better service quality can give a firm a competitive edge too.

As well as all the above aspects, the FTSE stock in question needs to be in a market that can be considered a growth market. Saturated industries may have no room for advancement. For example, if a new PC hardware manufacturer emerged, it would be less likely to be dubbed a growth stock than a new smartphone vendor.

Some FTSE growth stocks aren’t always making a profit so I cannot expect a dividend straight away. If a growth stock reaches its potential, I would expect dividends in the longer term. 

Risks to consider with FTSE growth stocks

One of these risks is that of an unproven business model. This firm has a higher risk as the business model is untried. Another risk I carefully consider is that of overvaluation. I find growth stocks are often overvalued — even if they do not generate much in the way of profits. Some are often running at a loss. Finally, competition is often rife in emerging industries. I must think of choosing the correct pick in any growth sector. 

In conclusion, I am always on the lookout for FTSE growth stocks for my portfolio. I carefully use the above guide and measure with the information available to me when dissecting a company and ensure I understand the higher risk associated with such stocks.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Jabran Khan has no position in any shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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