I have a range of both income and growth shares in my portfolio.
It can be easier to identify strong income shares, because often they have a long business track record. That can help me consider what they might be able to achieve in future, although past performance is not necessarily an indicator of what will happen next.
With many growth shares, though, a limited track record and sometimes undeveloped customer market can make it more challenging for me to decide how well I think they may perform in future.
Here are some things I consider when searching for potentially great growth shares I can add to my portfolio.
Market size
How big is the customer market likely to be for a certain product or service?
Ultimately that helps decide what sorts of revenues a company might be able to generate in future. I do not think great growth shares necessarily need a huge market. For example, Judges Scientific focuses on supplying technical instruments. That is a large market but not as big as the ones served by firms like Apple, for example.
But I do want to feel comfortable that the market is big enough and also wide enough that it could support a great business. Some growth shares have a business model that is largely reliant on a single key customer, for example. That is a business model laden with risk.
Smell check
I try to invest in businesses I understand. With growth shares, there can be new business areas that I need to research before I feel I understand them.
In doing so, I tend to apply a sort of smell check: what is my initial reaction to the business idea. For example, one of the reasons I have shunned Ocado shares is because I think the business model is closer to that of a commercial landlord than a tech company.
By building warehouses and distribution centres to service clients, Ocado’s business model strikes me as one that could have high capital expenditure costs and limited scalability. Its annual loss of half a billion pounds, announced today, was partly driven by a capex bill last year of almost £800m.
I feel similarly about Meta and its push into the metaverse. There may well be something in the metaverse as a future business idea. But for now it seems like a money pit with limited consumer traction.
Business model
Some businesses identify what they think might be a great area for future business growth. Renewable energy is a topical example.
But simply spotting where to dig for gold is one thing. Knowing specifically where and how to dig is another.
I think truly great growth shares benefit from a company having some unique competitive advantage. An example is the proprietary robotic technology of Intuitive Surgical. I do not own the shares because of the price, but I think the business itself is excellent.
So when looking at growth shares I could buy, I do not just focus on the market potential but also what sets a specific business apart from competitors over the long term. After all, if a business area genuinely is so promising, a lot of firms may be tempted to enter it. But typically there can only be a few really big winners.
