HOW TO DEVELOP A
GROWTH INVESTING STRATEGY

This educational guide explores how investors can develop a systematic approach to identifying and analysing growth opportunities while managing associated risks.

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Growth investing focuses on identifying companies expected to grow faster than the market average, offering potentially significant returns over time.

That attractive proposition of “beating the market” comes with its own set of challenges. These include the fact that identifying and investing in growth stocks requires developing a full understanding of what is meant by growth stocks and their potential pros and cons.

What Is Growth Investing?

Growth investing is a strategy used by investors to try to increase their capital by buying growth stocks, which are characterised by the expectation that their share price will outpace the market. 

Unlike value investing, which seeks undervalued companies trading below their intrinsic worth, growth investing prioritises future potential over current valuation metrics. Growth investors often accept higher price-to-earnings ratios in exchange for the prospect of accelerated earnings expansion.

The philosophy behind growth investing centres on identifying companies with particular features, including:

• Sustainable competitive advantages
• Innovative products or services
• Expanding total addressable markets (TAM)
• Reinvesting profits into research and development
• Not paying dividendsto shareholders

The overall approach is based on reinvestment to fuel continued growth and market share expansion. For investors, this means considering qualitative factors alongside quantitative metrics, including:

• The vision and execution capability of a company’s management team
• Scope for market opportunities
• Competitive positioning
• Network effects
• Strong brand recognition
• Holding patents protecting their competitive advantage.

Common Characteristics of Growth Stocks

Growth stocks typically exhibit above-average revenue and earnings expansion, often exceeding 15-20% annually compared to the broader market’s single-digit growth rates. Other features investors commonly look for when trying to identify new growth stocks include:

• Operating in expanding industries
• Being part of a new/growing market
• Small market capitalisation
• Speculative, innovative, or technology based business models

Ultimately, investors tend to target companies that offer new or unique products and services. These innovations create barriers to entry and pricing power that support sustained growth trajectories. 

Key Metrics for Growth Analysis

Evaluating growth stocks requires developing an analytical model which gives greater weight to metrics relating to earnings and potential earnings, including the revenue growth rate and earnings growth. 

Some of the metrics outlined in the table below are also used in the analysis of other types of stocks, such as value stocks, but for growth stock investors, these earnings-based factors are key.

Metric	What it measures	What it can miss / where it can mislead
P/E Ratio	Share price relative to earnings per share	The P/E ratio is often used as a guide because a high P/E ratio suggests that other investors are already committing to the possibility that a firm’s revenues will rise in the future. However, this metric does not work well with firms that are still operating at a loss or have negative revenues.
Forward P/E	Price relative to expected future earnings	Relies on analyst estimates which may prove inaccurate
P/S Ratio	Market capitalisation to revenue	Ignores profitability and cash generation
Revenue Growth	Year-over-year sales increase	May not translate to profit growth
Margin Trend	Gross/operating margin progression	Can be manipulated through accounting choices

Earnings growth, while sometimes negative in early-stage companies, provides insight into profitability trends and operational leverage.  As the primary indicator, investors will be seeking consistent earnings expansion over multiple quarters or years.

Earnings Growth Case Study 1 – (P/E calculation): A growth stock trading at $100 with earnings per share of $2 has a P/E ratio of 50 ($100 ÷ $2). Higher multiples often reflect higher growth expectations, which may or may not materialise.

Earnings Growth Case Study 2 (P/S when earnings are negative): A company with share price $50, 10 million shares outstanding, and $100 million revenue has a P/S ratio of 5 ($500 million market cap ÷ $100 million revenue). P/S focuses on sales, but does not show profitability or cash generation.

Growth vs Value Investing

Growth and value investing represent different approaches to stock selection. Both value and growth investors aim to buy low and sell high, but the underlying reasons for the price movements will differ. Though the distinction can blur in practice.

• Growth investors anticipate price appreciation from expanding business fundamentals

• Value investors expect reversion to intrinsic worth

As the two types of analysis prioritise different factors, the key risks associated with them also differ, as outlined in the table below.

Style	What it tends to emphasise	Typical risk/trade-off
Growth Investing	Future potential, innovation, market expansion	Higher price volatility, valuation risk
Value Investing	Current fundamentals, margin of safety, dividends	May miss transformative opportunities

The performance of growth versus value strategies varies with market cycles and economic conditions. 

During periods of economic expansion and low interest rates, growth stocks often outperform as investors pay premium valuation multiples for future earnings. Conversely, value strategies may excel during market corrections or periods of economic uncertainty.

Some companies exhibit both growth and value characteristics, challenging rigid categorisation. A mature technology company with stable cash flows might trade at reasonable valuations while maintaining above-average growth rates. 

Sector Analysis for Growth Opportunities

Historical data shows that certain sectors or categories of firms have typically produced a greater number of stocks which fall into the “growth stock” category. 

Being aware of the potential for certain sectors to be more likely to hold growth stocks therefore forms part of the assessment process. With sectors which typically require attention including:

• Technology: The tech sector remains the most prominent growth sector, driven by digital transformation, artificial intelligence, and cloud computing adoption. 

• Healthcare: Biotechnology offers growth potential through drug development pipelines and ageing demographics.

• Consumer discretionary: This sector can contain companies which capitalise on changing preferences and emerging markets. 

• E-commerce: Including streaming services, and electric vehicles which exemplify subsectors with structural growth tailwinds. 

• Financial technology: Fintech offers the potential to disrupt traditional banking through digital payments, blockchain applications, and alternative lending platforms.

“The stock market is filled with individuals who know the price of everything, but the value of nothing.”

Phillip Fisher

Company size

Considering the size of a company can also help identify growth stocks. There are no hard-and-fast rules but it makes intuitive sense that smaller firms have greater potential to expand than large ones which might be close to saturating a market and lack further growth potential.

The definition of a “small-cap stock” varies from investor to investor. Popular classifications include firms with a market capitalization of between $250m and $2bn. Alternatively, some investors identify small-cap stocks as those ranking within the bottom 10% of market capitalization on a given stock exchange. 

Risk Factors in Growth Investing

Growth investing carries specific risks which extend beyond a market-wide sell off in “the stock market”. These risks largely relate to investors basing valuations on potential future developments rather than established business practices.

Valuation compression

This occurs when investor sentiment shifts or macroeconomic factors such as an interest rate rise cause high-multiple stocks to reprice lower even if growth continues. This risk intensifies during market corrections when investors flee to safety.

Execution risk

Operational challenges can threaten growth companies as they scale operations and enter new markets. These can include, but are not limited to, product delays, competitive responses, or operational missteps can derail growth trajectories. 

External factors

The dynamic nature of growth sectors leaves them open to intervention from external forces. Risk factors to consider include regulatory changes, technological disruption, and macroeconomic shifts which might disproportionately impact growth stocks. 

Public health events can shift demand patterns dramatically, while geopolitical tensions may restrict market access.

Portfolio Considerations

Constructing a growth portfolio requires balancing potential returns with risk management. Some of the techniques involved can be applied to other types of strategies but are particularly important regarding growth stocks which typically have higher levels of price volatility.

• Position sizing: The amount of capital you invest in a stock should reflect your conviction levels and risk tolerance, with larger allocations to established growth companies and smaller positions in speculative opportunities. 

• Spreading risk: Diversification extends beyond sector allocation to include geographic exposure, market capitalisation ranges, and growth stages.

• Know your aims: An investment time horizon significantly influences growth strategy implementation. Longer holding periods allow companies to execute growth plans and enable investors to weather short-term volatility. 

• A buy-and-hold mindset: Patient capital often proves essential for capturing multiyear growth stories, particularly in sectors like biotechnology with extended development cycles.

Growth Stock ETFs:

Buying exchange-traded funds (ETFs), rather than individual stocks from a specific sector, is a relatively cost-effective way to buy a basket of stocks. 

Spreading capital allocation across a greater number of stocks increases the likelihood of you holding one that sees significant price appreciation and reduces the risk that one underperforming stock will have a significant impact on your overall performance returns.

Final thoughts

Growth investing requires patience, disciplined analysis, and the ability to look beyond current valuations to identify tomorrow’s market leaders.

Some of the analysis techniques and metrics used to identify and track growth stocks could theoretically be applied universally and to non-growth strategies, but growth strategies place a noticeable emphasis on earnings, and more specifically, earnings growth.

Visit the eToro Academy to learn more about growth stock investing.

Quiz

FAQs

How do investors research growth stocks?

Investors research growth stocks by analysing revenue and earnings growth rates, evaluating competitive positioning, and assessing market opportunity size. Additional research includes reviewing management quality, innovation pipelines, and industry trends through company reports, earnings calls, and sector analysis.

What does “priced in” mean?

“Priced in” means current market prices already reflect expected future growth or events. When growth expectations are fully priced in, stocks may not appreciate further even if companies meet targets, as investors have already bid up valuations based on anticipated performance.

Why do some growth stocks have high P/E ratios?

Growth stocks command high P/E ratios because investors expect rapid earnings expansion to justify current valuations over time. Premium multiples reflect confidence in future growth rates exceeding market averages, though these expectations create downside risk if growth disappoints.

When is P/E less useful?

P/E becomes less useful for companies with negative earnings, minimal profits, or highly cyclical businesses. Early-stage growth companies often lack meaningful earnings, making price-to-sales or enterprise value-to-revenue more relevant metrics for valuation comparison.

What’s the difference between revenue growth and profit growth?

Revenue growth measures top-line sales expansion, while profit growth tracks bottom-line earnings increase after expenses. Companies can grow revenue while sacrificing profitability through heavy investment or pricing strategies, making both metrics important for comprehensive analysis.