I never used to invest in growth companies. Investing in small-cap growth stocks seemed far too racy to me. Much better to invest in solid, reliable blue chips. You might not have the rapid growth, but at least there was hardly any risk of the share price crashing to zero.
Most blue chips are stable and consistent. But small caps can rocket or — as they’re often prey to shorters — they can fall to earth. Most investors’ risk aversion puts them off investing in growth companies.
How to pinpoint successful growth companies
But, wait a moment. What if you could pick just those growth shares that kept growing, and not those that weren’t successful? Sound too good to be true? It might be, but this is something I am working on and thinking through at the moment.
So how can you pinpoint the small caps which will grow, and avoid those that fall from the sky? Well… research, study, dig deeper. The evidence is there if you take the time to look. Browse the website, read the annual report, try the products, read the news and the buzz.
And, more than that — and this is the crucial part — study the numbers. I personally only invest in companies (whether you are talking about growth, value or anything else) that are currently profitable. After all, at the end of the day companies are meant to be profitable, and if they are currently not profitable, how can you trust them to be profitable in the future?
Then check the current and future P/E ratios. What I am looking to find here is a P/E ratio which is both fairly low and falling. This indicates that the company is both cheap, and growing. Volatility is almost inevitable, but if the share price tumbles at any point, as long as the fundamentals are still strong then I won’t panic sell.
Finally, as I am a contrarian investor at heart, I like to invest after the share price has fallen. That way you can turn what seems like the disadvantage of high volatility into a positive.
Why I’ve bought into this company
By working through this method I have unearthed a company that has impressed me so much I have bought shares in it. It’s called Globo (LSE: GBO). It’s an innovative software company which produces mobile, telecoms and e-business products.
Firstly, this company is cheap, with a P/E ratio of just 7. Secondly, the share price has fallen recently, which makes it a contrarian as well as a growth buy. And thirdly it is a company that is growing, and is working in the booming field of smartphone and tablet apps, and the ‘Bring Your Own Device’ market.
Often with growth shares such as this, part of the reason the business is so cheap is that it is still relatively unknown. But of course this is the time to buy, rather than when the company is well-known but the share price has already rocketed.
I have looked into the risks with this company and personally nothing troubles me about them. There will inevitably be volatility, but sit through the ups and downs and I am very hopeful that months and years into the future the share price will be a lot higher than it is now.
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Prabhat owns shares in Globo plc.