Growth investment style
Also written Growth style · Growth style investing · Growth oriented investment style
An active equity style that buys companies expected to grow faster than their peers, accepts a premium valuation for them, and aims at capital gain rather than income.
In plain language
Some companies are expected to grow much faster than their rivals. The reason might be a new product, a new market, an early lead, or a service so good that customers pay a premium for it.
Faster revenue and profit growth tends to show up in the share price. A manager who builds a portfolio around such companies is following the growth investment style.
The pay-off she is after is capital gain, not dividends. Growth companies usually pay very little out, because the profit goes back into the business.
The other main style is the value investment style, which buys shares that look cheap against what they are worth. A mix of both is called the blended style.
One warning sits in the workbook itself. Today's growth company becomes tomorrow's steady one.
How it works
Where it sits (section 18.8). Investment management styles are broadly classified into two on fundamental parameters — growth (stocks with high growth potential, expected to outperform the market) and value (stocks undervalued against their intrinsic value). A third, the blended investment style, combines both.
The engine (section 18.8.1). Superior growth can come from new products, new markets, early-stage companies, or a quality product or service that commands premium pricing. These raise the momentum of revenue and profitability, which in turn is reflected in the stock price. Future growth is a matter of analytical expectation based on fundamental analysis, reached either top-down or bottom-up.
The six characteristics of a growth company the workbook lists: high future earnings or profit growth; a monopolistic or niche product or service with high market share; low dividend yield or pay-out ratio, because most of the profit is reinvested to fuel growth; higher than peers' valuation; a higher risk parameter than peers; and early-stage companies.
Screening for them (section 18.8.1.1). Three rules first: define the objective clearly, select primary criteria that match the objective, set a threshold for each criterion. The primary screeners commonly used are growth of historical revenue and earnings, forecasted growth where available, and the industry growth rate — each taken both annually and quarterly, year on year. Filters then remove unwanted names: market capitalisation, size of revenue or profitability, leverage (debt-to-equity) and promoter shareholding.
How a growth manager reads a P/E (Chapter 12, section 12.5.3). A growth-oriented investor focuses on the denominator — earnings and their economic determinants — looking for rapid future EPS growth and implicitly assuming the P/E ratio stays more or less constant, so that as forecast earnings growth is realised the price rises. The value investor focuses on the numerator, the price.
No threshold is given. Neither section attaches a number to the style — no minimum growth rate, no maximum P/E, no portfolio limit. The thresholds are expressly left to the manager to set in her screen.
A worked example
Illustrative figures. Shruti runs a growth mandate and has Rs 20,00,000 to deploy. Her screen: three-year revenue growth above 20%, forecast EPS growth above 18%, industry growth above 10%. Her filters: market capitalisation above Rs 5,000 crore, debt-to-equity below 0.5.
| Company P | Company Q | |
|---|---|---|
| 3-year revenue growth | 28% | 9% |
| Forecast EPS growth | 24% | 7% |
| Industry growth | 14% | 4% |
| Dividend pay-out | 5% | 45% |
| P/E | 54 | 16 |
| Debt-to-equity | 0.2 | 0.9 |
Company P clears every primary criterion and both filters. Company Q fails on growth and on leverage. Shruti puts the full Rs 20,00,000 into P.
Notice that the P/E of 54 did not disqualify P. On this style, a higher-than-peers valuation is a listed characteristic of a growth company, not a reason to reject it. Shruti's bet is that P's earnings will grow into the 54 — if EPS rises 24% a year for three years, earnings nearly double, and at an unchanged P/E the price roughly doubles with them. Her Rs 20 lakh would be worth about Rs 38,00,000.
The risk is on the same page. If growth slows to 8%, the market is likely to re-rate P towards a peer multiple. The valuation and the earnings would fall together.
Why NISM asks about it
Chapter 18, section 18.8 (Investment Management Styles) and 18.8.1 (Growth Investment Style), with 18.8.1.1 on screens. Chapter 12, section 12.5.3, covers the same split from the index side and supplies the P/E numerator-versus-denominator contrast.
Expect a definition question pairing growth and value, a which-of-these-is-a-growth-characteristic question (where low dividend pay-out and higher than peers' valuation are the correct but counter-intuitive answers), and a question on which part of the P/E ratio a growth manager focuses on (the denominator, earnings).
Common exam traps
- This is not the growth investing of the private equity papers. There the term means taking a minority stake in an unlisted company to fund its expansion. Here it is a listed-equity style. Same words, different concept and different paper — check which one a question is set from.
- A high valuation is a characteristic, not a disqualifier. Growth companies are expected to trade above peers; the style accepts that.
- Low dividend yield is the growth signal; high dividend yield is the value signal. Candidates reverse these.
- Growth needs a forecast; value needs a comparison. Growth rests on analytical expectation of future earnings, which is why the workbook calls it a matter of expectation.
- Growth companies do not stay growth companies. The workbook says they attain steady-state growth over time — so a growth portfolio has to be reviewed, not just bought.
- Do not confuse the style with momentum investing. Growth uses fundamental analysis; momentum uses price and volume.
Where this is taught
Free preparation for NISM Series XXI-BRelated terms
- Active investingAn investing approach that involves picking individual securities to try to beat the return of the broader asset class, rather than simply tracking it.
- Style indexAn index of value stocks (low P/E, low P/B, high dividend yield) or growth stocks (the reverse), built to benchmark style managers — with far higher turnover than broad market indices.
- Core and satelliteA portfolio built from a large, low-cost, usually passive core — about 70% to 80% — plus smaller satellite portions managed actively to capture shorter-term opportunities.
- Fundamental P/EThe P/E ratio implied by the dividend discount model — derived from a firm's payout ratio, required return and expected dividend growth rather than observed from the market price.
- Growth stockA share the market expects to grow faster than its peers — typically high P/E, high P/B and low dividend yield, bought for capital gain rather than income.
- Momentum investingAn active strategy that rides an ongoing price trend — long in a rising trend, short in a falling one — worked from price and volume data rather than a company's fundamentals.
- Value investment styleAn investment management style of buying stocks priced below their intrinsic value, on the belief that the market has mispriced them and will correct that mispricing over time.
- Value stockA stock classified, typically for index and benchmarking purposes, as cheap relative to its fundamentals — low price-to-book, low price-to-earnings and high dividend yield being the workbook's own ratio criteria.
- Portfolio Turnover RatioThe lower of a scheme's purchases or sales of securities in a period divided by its average net assets — a ratio of 2 means holdings are kept, on average, for about six months.
- Style driftA fund manager departing from the investment style the scheme promised — such as a value fund filling up with fully-valued front-line stocks — so investors carry risks they did not sign up for.