Investing in stocks and shares is my preferred way to try and build my wealth and create passive income. That’s because of the miracle of compounding – where interest is earned on top of interest, creating an ever-growing pot of money. For this to work, dividends are important and I have many higher-yielding shares in my portfolio.
As well as having dividends flowing in from these shares, I want to invest in stocks and shares with above-average growth potential.
Therefore, my aim is to have a diversified portfolio, with smaller-cap and growth stocks, alongside higher-yielding shares.
My 4 key steps for picking growth shares
All of these points below are super-important for me when it comes to selecting growth shares.
The first point is revenue growth. I want this to be both strong and consistent. The level of growth depends partly on the industry, how revenue growth compares to competitors and the market opportunity. So there’s no definitive figure on what the increase should be year-on-year.
Second, I want to see revenue increases filter into profits and my preferred profit measure is operating profit. As with revenue growth, there’s no exact amount I’m looking for, but consistency, as well as being better than alternative investments and comparable companies, are key.
Third, I want to see a ‘current ratio’ of at least two. That means current assets are comfortably covering short term, or current, liabilities. It also means there’s less likelihood of working capital issues. So this is a balance sheet test.
Then finally, I want to see a price/earnings to growth (PEG) ratio, below 0.7. Jim Slater in The Zulu Principle says this is what growth investors should be looking for. It means the valuation compared to growth forecasts isn’t excessive. It can therefore help when it comes to identifying undervalued growth shares. In my opinion such shares have the potential to be very profitable.
My qualitative criteria
On the qualitative side, I would like to see management holding a meaningful amount of the shares. I ideally want to see the senior team among the top 10 holders, something that can be found in the annual report, or owning at least 5% of the shares.
And I’m keen on long service of directors, suggesting a board that is cohesive and confident in the business the directors work for. A lot of executive rotation can be a red flag, as can executives who can’t hold on to a job for very long.
Investing in growth stocks and shares
This is my plan for investing in growth stocks and shares. I think the UK has plenty of shares that fit the bill and they can be found on both the FTSE and AIM markets.
By finding these gems and letting them appreciate within my portfolio I hope they can help me create a strong compounding effect in my portfolio and cause it to grow quicker.