How To Spot Growth Shares

Date: January 14, 2014

Growth appears to be back on the agenda again. For years, growth has been put on the back-burner as companies focus on efficiency, downsizing and cost cutting to survive the fallout from the banking crisis of 2007.

Who can blame them for battening down the hatches?

The financial calamity of 2007 was one of the worst collapses in financial history. The watchword for many businesses after the banking debacle was survival. But seven years after the event, there are tangible signs that green shoots of recovery are starting to appear.

I have even heard one financial commentator make reference to the biblical story of the seven years of famine followed by seven years of plenty. He might just have a point.

The US economy is back to growing ways and so too are the UK and European economies. Elsewhere, China became the world’s largest trader overtaking the US; Jaguar Land Rover recently reported record-breaking global sales for 2013, while Airbus delivered a record number of planes last year.

There are certainly enough signs to suggest that the worst is behind us and it might not be too premature to start looking around for companies with a penchant for growth.

Growth companies by definition are firms that experience faster-than-average growth rates. Businesses involved in exciting industries such as biotechnology and high technology are examples of potential growth companies. But they are by no means the one ones that can grow quickly.

When looking at the topic of growth investing it is hard not to refer to Peter Lynch.

Lynch, who managed the Fidelity Magellan fund between 1977 and 1990, claimed that small investors can often be better placed than professionals to spot potential growth companies.

However, it is also worth bearing in mind that Lynch came unstuck with many of his speculative picks too. He openly admits that over half his choices were mistakes, which should underline the potential risk of investing in growth companies compared to, say, mundane income-generating shares.

Investors should therefore be prepared for hefty losses if, like Lynch, they happen to get it wrong. That said the potential gains from investing in successful growth companies can be quite substantial if you do get it right.

For those who haven’t been put off completely by the risks associated with growth investing, here are some of Lynch’s pearls of wisdom to ponder over.

Be Receptive To Ideas

Lynch once said it is possible to find spectacular performers from the shopping malls if you stay half-alert. Interestingly, one of the best growth shares over the past few years has come from a supplier to the supermarkets. Shares in Super Group have almost trebled since 2010. Not bad for a maker of instant tea and coffee. It is also one that you might have spotted as you wheel your trolley up and down the food aisles.

Stay Small

Lynch is known to favour small companies that have been profitable and just seem to carry on growing. Old Chang Kee, for example, is one company that appears to fit the bill. Its shares have more than doubled in three years as demand for curry puffs show little sign of waning. Despite the share price rise, the company is still only valued at less than S$100 million.

Check The Numbers

Simply relying on intuition is never quite enough when investing. If you think you have found a good company then back your instinct by checking the numbers carefully. Ensure that sales of particular products or service make up a significant proportion of group revenues to make a difference to bottom-line profits.

Also make certain that the company’s valuation is lower than its earnings growth. In other words, ensure that you are not overpaying for the shares. Just because it is a growth share doesn’t mean you have to pay over the odds to own it.

To your investing

David Kuo

This article is contributed by The Motley Fool Singapore