Growth investing basics. Compounders, identified.

Growth investing buys companies with above average revenue and earnings growth, expecting the growth to continue and compound for years or decades. The strategy made famous names like Peter Lynch, Phil Fisher, and the Magellan Fund. It has produced more major individual stock multi baggers than value investing because the math of compounding growth produces explosive returns when the growth persists.

The honest version is mostly about distinguishing real durable growth from temporary momentum. The hype stocks of any era look like growth stocks. Most of them are not. The few that are produce extraordinary returns. The skill is in the selection.

What growth investing is

Growth investing focuses on the future. The current earnings matter less than what the earnings will be in 5 years. The current valuation multiple matters less than what the multiple will compress to as the company grows into it.

The thesis. A company growing earnings at 25 percent per year for the next 10 years will end up with 9x the current earnings. Even at a flat valuation multiple, the stock would be 9x higher. The growth investor captures this compounding by buying early in the growth runway and holding through the compounding period.

The risk. The growth does not continue. The company that was supposed to grow 25 percent per year for 10 years grows only 10 percent and then stalls. The high multiple the investor paid never gets supported by the growth they expected. The stock languishes or declines.

The metrics growth investors watch

Revenue growth rate.

Annualized growth in top line revenue. Above 15 percent is growth territory. Above 25 percent is high growth. Above 50 percent is hyper growth (and rare to sustain).

Earnings growth rate.

Annualized growth in earnings per share. Should accelerate or at least match revenue growth as the company achieves operating leverage.

Return on invested capital (ROIC).

How efficiently the company generates profit from capital. Above 15 percent sustained suggests the growth is being created profitably. Below 10 percent suggests growth is being bought rather than earned.

Operating margin expansion.

Profitability improving as the company grows. Operating leverage means each additional dollar of revenue produces more than a dollar of incremental earnings.

Free cash flow growth.

Cash generation tracks the earnings growth. Growth without cash flow is suspect.

Total addressable market (TAM).

The size of the market the company can grow into. A company with $100 million in revenue in a $100 billion market has long growth runway. A company at $5 billion in a $10 billion market has limited runway.

Market share trajectory.

Whether the company is gaining or losing share. Gaining share in a growing market is the strongest combination.

The quality filters

Sustainable competitive advantage.

The growth has to be protected from competition. Network effects (more users make the product more valuable). Switching costs (hard to leave once a customer). Brand. Scale advantages. Patents. Without a moat, growth gets competed away.

High customer retention.

SaaS companies measure net revenue retention. Above 100 percent (existing customers spending more) indicates a strong product. Above 120 percent is exceptional.

Insider ownership and alignment.

Management with significant ownership has skin in the game. Founders running their companies often produce the best long term growth.

Reinvestment opportunities.

The company has profitable uses for its capital. Reinvesting earnings into growth opportunities produces the compounding. Companies returning capital to shareholders (dividends, buybacks) signal the end of high growth.

The Peter Lynch framework

Peter Lynch ran Fidelity's Magellan Fund from 1977 to 1990, producing 29 percent annualized returns. His approach combined growth investing with practical observation.

Invest in what you know.

Companies whose products you use and understand. Local observation often beats Wall Street research.

The PEG ratio.

P/E divided by the growth rate. PEG below 1.0 suggests the growth is undervalued. PEG above 2.0 suggests overvalued. The PEG normalizes the valuation by the growth.

Six categories of stocks.

Slow growers (3 to 5 percent). Stalwarts (10 to 12 percent). Fast growers (above 20 percent). Cyclicals. Turnarounds. Asset plays. Different categories require different analysis and have different return profiles.

Ten baggers.

Stocks that produce 10x returns. Lynch's framework identified what made a ten bagger and how to ride it. Most retail investors sell after the first double. The ten bagger requires holding through the full multi year growth.

The Phil Fisher framework

Phil Fisher's Common Stocks and Uncommon Profits (1958) is the foundational text on growth investing. Buffett credited Fisher (along with Graham) as a major influence.

Fisher's framework focuses on qualitative business analysis. Fifteen points to evaluate a company including product potential, R and D effectiveness, management quality, profit margins, accounting controls, labor relations, and the founder's vision.

The scuttlebutt method. Talk to customers, competitors, suppliers, former employees. Build a mosaic understanding of the company from people who actually interact with it.

Long term holding. Fisher held positions for decades when the business continued to grow. The compounding of growth over decades produces returns that frequent trading cannot match.

What kills growth investors

Paying too much for too little growth. The high valuation requires high growth to justify. When the growth disappoints, the multiple compresses and the stock falls dramatically. The 2022 tech selloff hit many growth stocks that were priced for perfection.

Chasing hype. The "next big thing" stocks of any era. Most produce no returns despite massive media attention. Selecting real growth requires looking at the metrics, not the narrative.

Selling winners too early. The growth investor who sells after a 50 percent gain misses the 10x compound. The discipline to let winners run is critical.

Averaging down on broken growth stories. When the growth thesis breaks, the stock often falls 70 to 90 percent. Averaging down on a broken thesis compounds the loss.

Ignoring valuation entirely. Even growth investors need to pay attention to what they are paying. The growth has to be priced reasonably for the math to work.

The GARP hybrid

Growth At a Reasonable Price (GARP) combines growth and value principles. Buy companies with strong growth at reasonable valuations.

GARP avoids the pure growth trap of paying too much for the growth. It also avoids the pure value trap of buying cheap companies with no growth runway.

The PEG ratio is the GARP metric. PEG below 1.0 with a quality business and durable growth is the GARP sweet spot.

Most successful long term portfolios have GARP characteristics. Quality businesses growing at reasonable rates bought at reasonable prices, held through the compounding period.

The retail implementation

For most retail, growth investing through diversified ETFs is the practical approach. Growth factor ETFs (VUG, IVW, IWF) provide diversified growth exposure.

For those who pick individual stocks, focus on a small portfolio of 10 to 20 high quality businesses with sustainable competitive advantages and long growth runways. Multi year holds. Quarterly fundamental reviews.

Read the books. Common Stocks and Uncommon Profits (Fisher), One Up On Wall Street (Lynch), Beating the Street (Lynch), Snowball (Buffett biography).

Where the audit fits

The audit is for active trading. Growth investing is long term holding. Both can coexist in a portfolio. The active trading portion produces income. The growth portion produces long term compounding. The audit structures the active portion. Five to seven pages.