The best, simplest way to build significant wealth over the long run is, arguably, to just plunk meaningful sums in one or more low-fee, broad-market index funds -- and to do so regularly. The overall stock market has averaged annual gains of close to 10% over many decades, and it should deliver a similar return, plus or minus a few percentage points, over your long investing period.
If you'd like to aim for higher-than-average returns, consider adding some growth stocks to your mix.
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What are growth stocks?
Growth stocks are tied to companies growing at an above-average clip. Many such companies are relatively small, ramping up their business quickly. Others can be big and established.
In general, huge companies aren't able to grow as briskly as many small ones, but there are more than a few massive companies getting more massive at a fast rate. Visa, for example, recently posted fourth-quarter earnings up 19% year over year, while Taiwan Semiconductor saw its second-quarter revenue pop more than 43%.
Characteristics of great growth stocks
Here are some traits that can help you identify good growth stocks. Some apply to non-growth stocks, too.
- Growth: Their top line -- revenue -- should be growing quickly. If their bottom line -- earnings -- is growing briskly too, that's a plus. If they're not yet profitable, it's good if they're getting close to that, with losses shrinking.
- Innovation: They will often offer an innovative product or service that is quickly being embraced by customers.
- Low debt: It's not the end of the world if a company takes on debt to fuel its growth, but the less debt, the better, and the lower the interest rates, the better. (You might find interest rates listed in footnotes in financial reports.) Check to see if the company's debt is manageable: Is the company generating ample cash to cover obligations?
- Sustainable competitive advantages: A fast-growing company with an innovative product may not be a great prospect if it's easier for others to introduce similar offerings. This means high barriers to entry, such as when there's proprietary technology, exclusive licenses, or strong brand loyalty, can be powerful competitive advantages.
- Great growth potential: It's a big plus if a company's target market is large. This is sometimes referred to as a company's total addressable market (TAM).
- Solid market share: It's a nice green flag if a company is already a significant player in its niche. Ideally, market share will be growing, too.
- Good words from trusted sources: Don't buy stocks on someone else's word without doing your own reading and thinking about them. But you might find some great prospects from trusted sources. Our Motley Fool articles often cover various growth stocks, for example. (Note that not all Fools will agree on the attractiveness of any stock. Opinions vary in the investing world.)
Motley Fool co-founder David Gardner introduced a framework for finding growth stocks that has been quite effective. He dubbed it Rule Breakers investing. While one school of investing thought will have you only buying seemingly undervalued stocks, there's a case to be made that it can be worth paying a premium price for outstanding growth stocks -- and Rule Breakers investing shares that view.
Set yourself up for success
As you start looking for good growth stocks for your portfolio, you might improve your long-term performance by keeping these things in mind:
- Growth stocks can be volatile: The recent stock market downturn has illustrated that very well. Even big growth stocks such as Amazon recently had stocks down more than 50% from their 52-week highs. You need to be prepared for such volatility. And, ideally, try not to pay too much of a premium for any given stock. Fortunately, this is a particularly promising time to hunt for great growth stocks priced attractively.
- Diversify: Our Motley Fool investing philosophy suggests spreading your money across at least 25 different individual stocks. This can prevent you from ending up with too many eggs in a basket that implodes. (Not every growth stock will remain one.)
- Plan to wait and watch: Aim to hang on to your stocks for at least five years, if not several decades. Don't hold blindly, though -- keep up with their progress and developments, so that you'll notice if things start heading south.
Other paths to wealth
Growth stocks are not your only choice. Indeed, many people swear by value investing instead -- including Warren Buffett. Value investors aim to buy into solid companies when their stocks are trading below their intrinsic value. Dividend-paying stocks are also terrific candidates for your long-term portfolio, as the share prices of healthy, growing dividend payers will likely rise over time, while their payouts will also be increased.
These kinds of stocks are not always mutually exclusive. Even Warren Buffett's company, Berkshire Hathaway, recently held more than $1 billion worth of Amazon and more than $120 billion worth of Apple. A growth stock can become undervalued -- especially at times like right now, after a market crash -- offering the best of both growth and value investing worlds. And many of these companies pay dividends, too.
Remember that some good index funds are all most of us really need, but if you want to try to juice your returns, consider growth stocks.
