AMFI Registered Mutual Fund Distributor | SEBI registered Investment Adviser
FSM LOGO

                    


titl_l_gif
Research
title_r_gif
Share | Email Print more
Growth Investing: Grow Your Pie
December 1, 2009

We cover the growth investment style in detail and evaluate two FSM recommended growth funds.


Author : iFAST Reseach Team



Untitled Document

We have briefly covered the various styles of investment in our previous article. Let us understand growth investment style in this article.

What exactly is growth investment style?

The growth investment style indicates the approach of investing in companies which have a good growth potential. Buying a growth stock is akin to sowing a seed and watching it grow into a big tree.             

Hence, growth-oriented investors usually look for the following characteristics in growth stocks: 

  • High Earnings per share (EPS): The rapid growth in earnings of a company is represented by a strong year-on-year increase in EPS.
  • A competitive edge: To sustain strong growth rates, the company needs to have a convincing edge over other companies. 
  • Small size: A well-known proponent of growth investing, Jim Slater has said, “Elephants don’t gallop.” Usually, small and mid cap companies are favoured because smaller companies have greater propensity for explosive growth as compared to the larger ones.

A well-known example of a growth stock has been Coca Cola Ltd; it sustained strong growth rates for many decades until recent years.

Advantages of Growth investing

The main advantage of pursuing a growth investment strategy is that this approach can result in big returns. The markets generally price a stock based on the estimated earnings of the stock. Thus, an early identification of a stock with strong growth potential will greatly benefit the investor. With every earnings upgrade, the price of the stock in general will increase in value. If you can foresee the potential upgrades and buy the stock much before the upgrades happen then your stock investment is likely to head upwards.

For a company to maintain the above average performance in the market, the following characteristics are important:

  • Visionary leadership and a capable management team
  • Sunrise industry
  • Unique competitive advantage that is scalable.
  • A significant monopoly over the competition or control of raw materials

You will realise these characteristics are not permanent and may change anytime. Hence, following a growth strategy requires you to be constantly aware of the various macro- and micro-factors affecting the stock you have bought. Any sign of decadence and you must be ready to place your money elsewhere.

Limitations of Growth investing

The main drawback of this strategy is that a growing company does not necessarily mean that the stock is a growth stock. Confusing? Let us understand the difference between the two.

For a growth company, the earnings are expected to grow at rate over and above the companies in its peer group. Whereas, a growth stock is the one whose total returns (capital gains + dividend income) exceed the average returns from the market. Based on this argument, a growing company should logically be a growth stock as the companies which have solid growth potential will have a tendency to outperform the markets with ease.

However, this relationship of a growth company being equivalent to a growth stock will not exist if the growth company’s stock price is overvalued. When the market participants price the future expected returns into the stock’s price, before the stock achieves that performance, the stock is overvalued. This scenario is quite common amongst the blue chip stocks.

Here’s an example to illustrate the point:

Stock A was trading at a price of Rs. 100. The stock is expected to achieve a year-on-year growth of 20% consecutively for 3 years. However, some research analysts are optimistic that the stock can maintain this growth for next 10 years instead of 3 years. Due to the bullish reports, the market players will rush in to buy the stock and thereby, propelling the price to let’s say, Rs. 200. On the other hand, Stock B which is similarly priced at Rs. 100 is also expected to achieve a year-on-year growth of 20%. As there was no significant coverage, the price remains around Rs. 100.

Assuming that, both the stocks eventually achieve 20% growth year-on-year in  the next 10 years, an investor of Stock B is more likely to receive higher returns. This is because the price of Stock B is not inflated at the time of purchase, unlike Stock A.

Another limitation of this style is that there is no guarantee that a company with sterling past performance may hold on to its ace performance in the future.

Performance of FSM recommended growth funds against the benchmark

In India, some fund managers adopt growth investing style in their fund management. At Fundsupermart.com, we recommend the HDFC Top 200 fund and DSP Blackrock Top 100 equity fund.

Let us evaluate their performance against the benchmark, BSE Sensex 100:

Annualised Returns

1 year

3 years

5 years

HDFC Top 200 fund

89.55%

16.48%

31.02%

DSP Blackrock top 100 equity fund

63.86%

16.28%

29.55%

BSE Sensex 100

68.45%

8.06%

22.42%

Source: iFAST Compilations

The HDFC Top 200 fund has outperformed the benchmark consistently for the past 5 years. While the DSP Blackrock Fund has shown underperformance lately, its long-term track record shows superior performance against the benchmark.

If you wish to see how these funds perform against other benchmarks, please visit our chart centre tool. Here, you can mix and match the funds and benchmarks for comparison.

Apart from performance, you should also evaluate funds according to their expense ratios to preserve your gains from the fund.

Fund Name

Expense Ratio

HDFC top 200 fund

1.81%

DSP Blackrock top 100 equity fund

1.90%

Source: iFAST Compilations  

Both funds do not differ significantly in their expense ratio.

Conclusion

Growth investing can become profitable if investments are planned over medium to long-term. Hence, you can consider adding funds having growth strategy in your portfolio.


iFAST and/or its content and research team’s licensed representatives may own or have positions in the mutual funds of any of the Asset Management Company mentioned or referred to in the article, and may from time to time add or dispose of, or be materially interested in any such. This article is not to be construed as an offer or solicitation for the subscription, purchase or sale of any mutual fund. No investment decision should be taken without first viewing a mutual fund's offer document/scheme additional information/scheme information document. Any advice herein is made on a general basis and does not take into account the specific investment objectives of the specific person or group of persons. Investors should seek for professional investment, tax, and legal advice before making an investment or any other decision. Past performance and any forecast is not necessarily indicative of the future or likely performance of the mutual fund. The value of mutual funds and the income from them may fall as well as rise. Opinions expressed herein are subject to change without notice. Please read our disclaimer in the website.

 


Comments (0) | Comment on this Article
 (Click on Comments/Comment on this Article to show or hide comments/post a comment)
USEFUL LINKS
Recommended Funds
Recommended Portfolios
Chart Centre
Risk Profiler