Looking back at growth shares of the past, from Amazon to Microsoft, it can seem incredible that some people really did buy these shares at the start of their first few years of dynamic growth, watching their investments grow massively.
I expect such lucrative investments to keep happening now and in the future. But to benefit from that, I need to be able to identify the right growth shares when they still trade at an attractive price. Here are two tips that I think help me in my efforts to do that.
Focus on demand growth
It is possible for a company to grow quickly in an established industry that has little or no customer growth overall. For example, it can disruptively take market share from rivals.
But I think a more reliable place to hunt for growth is in industries where customer demand is set to explode in the years ahead. Look back at some of the biggest growth stories of recent decades from an investing perspective, such as Tesla, Airbnb and Spotify. They were not necessarily all the first in their industry. But what unites them is that they were all there in the early days of business areas that went on to see explosive growth.
I do not think it necessarily matters whether the company itself has basically created that market, like Airbnb, or whether it is riding on the coattails of a pioneer. The key point is that exponential growth is easier for a company to achieve when the market it serves undergoes massive, sustained demand growth from customers.
Growth shares should have a strong business model
When it comes to a hot area of the economy, as basically every market mania in history reminds us, simply turning up to play is not the same as winning the game. There are lots of electric vehicle start-ups today just as there were once lots of motor car start-ups.
In the early days, simply being involved in a hot industry can push up the price of growth shares – sometimes dramatically. But ultimately, even if they are willing to wait, smart investors will want to see a return on their money. So they look for companies with a strong business model. Even if a company is not profitable at the moment, if it does not have a pathway to future profitability it may be a money pit. That can destroy not create shareholder value.
So, while I would consider investing in companies that are not yet profitable, I would not put money into one that lacked a clear strategy to convert its market position to profitability in future. Even then, although the lack of profits today would not stop me buying a share, I do think profitability is a proof that a business model actually works. So sometimes I wait to invest in growth shares until a company has turned a profit, although that may mean I pay more for my shares than would have been the case before.
