Consistently adding money to your holdings in companies that are delivering above-average growth can be an effective stock-picking strategy. The beauty of growth investing is that all it takes is a few big winners to see a significant improvement in your returns.
To give you some ideas, here are three promising growth stocks I would feel confident buying today.
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NetEase: Riding the growth in mobile games
Mobile games made up the fastest-growing segment of the video game industry in 2020 as engagement levels surged across platforms. The increasing usage of smartphones makes mobile games easily accessible for a global audience, which helps explain why NetEase (NTES 0.11%), a leading online game producer in China, continues to deliver market-beating results for investors.
The stock gained 56% in 2020 as revenue growth accelerated through the first three quarters of the year to 27% in the third quarter. In addition to its online games segment, NetEase has a fast-growing online education business and also generates a small percentage of revenue from its Yanxuan e-commerce platform. But online games is by far its largest segment, comprising 70% or more of its top line in recent years.
While video games can be a fickle marketplace, NetEase is known for delivering quality gaming experiences that keep players coming back. Two of its biggest titles -- Westward Journey Online 2 and Fantasy Westward Journey -- have remained popular for more than 15 years.
NetEase also has important licensing arrangements with Activision Blizzard and Microsoft to launch exclusive titles in China. These include Blizzard Entertainment's World of Warcraft, Overwatch, and Diablo 3, in addition to Microsoft's Minecraft.
Currently, NetEase is co-developing Diablo: Immortal with Blizzard. It also has a partnership with Walt Disney's Marvel Entertainment to co-develop games, television series, and comic books featuring characters from the Marvel universe. All of these partnerships are a testament to NetEase's expertise in developing games, as well as the trust that these companies place in NetEase's corporate culture to handle precious intellectual property.
The shares are up 240% over the last five years. With strong performance from existing games and a pipeline of new releases in the works, NetEase is positioned to deliver market-beating returns.
Okta: A leading identity cloud management platform
Okta's (OKTA -0.89%) identity cloud platform helps businesses connect their employees to apps and websites securely, and growth has been explosive. In the fiscal 2021 third quarter, revenue climbed 42% year over year as the platform continues to win the business of large companies.
As the company scales, it is driving profits higher. Trailing 12-month free cash flow reached $96 million as of the latest report. For the third quarter alone, Okta generated a robust free cash flow margin of 19.1% of total revenue, revealing a very profitable business taking shape.
The lucrative market that Okta serves will obviously attract competition over time. However, Okta has quickly captured a leadership position and is already competing favorably with the likes of Microsoft -- Okta's primary rival in this space.
Still, Okta should be able to hold its own against tech heavyweights. Microsoft entered the market in 2014 with Azure Active Directory, but customers still choose Okta because it provides a neutral identity cloud solution that is platform agnostic. It works with a variety of cloud and IT infrastructure providers, including Amazon's cloud services, Zoom, salesforce.com, Oracle, Cisco Systems, and even Microsoft Office 365.
As Okta continues to grow free cash flow, it's able to invest more resources in new product features and services. Once Okta brings a new client on board, it's common for those customers to expand their use of the platform. This helps drive more revenue growth and improves Okta's free cash flow margin, since selling additional services to existing customers comes at a lower expense than chasing down new clients.
Even though the stock has already earned investors more than a 10-fold gain over the last five years, Okta's addressable market is much larger than its current trailing 12-month revenue of $768 million. Okta will almost certainly be a much larger and more valuable business in 10 years than it is today, which is why the stock remains a buy at these lofty levels.
Wayfair: Winning the war for home goods spending
A promising play on the growth of e-commerce is Wayfair (W -3.72%), one of the leading online retailers for home goods. The stock rocketed higher in 2020 as revenue growth accelerated during the pandemic, but the new year is still a great time to start a position.
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The shares might look expensive, but they appear reasonably priced relative to Wayfair's growth prospects. Consider that that company has grown revenue twice as fast as Amazon over the last five years. While its stock price climbed 700% over that time, it still trades at a price-to-sales (P/S) multiple of just 2.5 as of this writing.
Wayfair is already a large online business with $13 billion in revenue generated over the last four quarters. In the third quarter of 2020, revenue growth clocked in at an impressive 66% year over year. That level of growth reflects consumers' recent increased willingness to invest in comfortable home furnishings rather than going out and risking exposure to COVID-19.
But Wayfair is benefiting from two other long-term trends as well. One is rapid growth in urbanization, as more people leave rural areas for cities. Another is the massive shift of brick-and-mortar spending moving online. Wayfair is already winning a healthy share of that shift in spending, which points to plenty of growth ahead.
As with all growth stocks, don't fret too much about recent stock performance or valuation. Instead, focus on the long-term trajectory of where the business is headed and make investment decisions accordingly.
