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3 simple steps for growing a million-pound Stocks and Shares ISA

A million-pound Stocks and Shares ISA is possible if you invest as much as you can regularly and approach the stock market with caution.

It’s important to learn as much as you can about investing and to focus on good-quality, growing businesses. Personally, I’d avoid punting on the more-speculative stocks available and aim for steady, rather than rapid progress instead.

Here’s my simple 3-step plan:

Step 1: know what kind of beast you’re dealing with

Companies listed on the stock market behave in different ways depending on the characteristics of their underlying businesses. So before plunging into buying shares, I reckon it’s a good idea to identify what kind of beast you’re dealing with.

The best advice I’ve come across on the subject is contained in well-known US investor Peter Lynch’s book One Up on Wall Street. Lynch suggests using six categories for sorting out different companies: Slow Growers, Stalwarts, Fast Growers, Cyclicals, Turnarounds and Asset Plays.

I think it’s a useful model that has saved me from making some investing blunders. For example, sometimes cyclical firms have the appearance of fast-growing enterprises. But because the underlying operation is cyclical, rapid increases in earnings can reverse direction without much warning, taking the share price down too.

Step 2: look for strong finances

Shares have the best chance of going on to perform well if the underlying business has strong finances. I’d look for a robust balance sheet that isn’t overloaded with debt and which ideally indicates the firm has a chunk of cash in its coffers.

After making sure the business is financed well, we want to know that trading is profitable and worthwhile. I reckon Purplebricks is a good recent example of pointless trading. Revenue has been growing fast but so has the operating loss. It’s risky to increase turnover if losses aren’t reducing too.

Ideally, I want to see annual rises in revenue, profits and incoming cash flow. And there’s nothing better for proving the success of an enterprise than a dividend payment to shareholders that rises a little each year.

Step 3: focus on compounding

Finally, the key to building wealth in your Stocks and Shares ISA is to focus on compounding, in my view. You can do that by reinvesting the dividends you receive from your shareholdings and by recycling funds into more shares when you eventually sell an investment.

The great thing about compounding is that it grows your money exponentially – at an ever-accelerating pace. That means the biggest absolute gains will occur in the later years of your holding period. So it’s important to keep going. When you’re recycling your gains into the shares of great companies, your best friend is time.

In the long run, I think you have a good chance of growing your Stocks and Shares ISA into a million-pound fund. Good luck on your investing journey!

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Kevin Godbold has no position in any share mentioned.  The Motley Fool UK has no position in any of the 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.