You Can Score With Growth Companies

Growth shares are companies which are expanding and whose earnings a share are growing faster than those of companies or listed companies in general.

Typically, these companies have dynamic management, a niche market, a new invention, new technology or a special service. They are often also smaller companies. As Jim Slater says in his book the Zulu Principle: “Generally speaking, elephants don’t gallop”.

It is in shares in this type of company that very large profits can be made. The profits come from two sources: higher earnings and the willingness of investors to rate these companies as superior.

To put it another way, higher earnings and a higher earning multiple will result in significant capital appreciation in the share price.

You need to find these winners and most importantly you need to keep them. There is no point in selling them at a ten percent profit. You should expect these shares to increase in value by five to ten times the initial investment at least. You need to let your winners run! Investments that show the greatest annual increase are those that are kept between three and eight years.

Investors must not take profits until it is clear that the company is going ex-growth and that the company’s rating is no longer justified. They must start underperforming or lagging or no longer make new highs before you sell. Investors do need experience to get this right.

Psychologically, investors do not want to risk a profit but it is more “risky” to sell a winner to early than it is to keep it. As long as you can sell at a profit, because you are already sitting on substantial gains, you risk more by selling early than by keeping the investment.

So where should you look for these companies?

Well, they’re often smaller than the leading shares or blue chips. They are normally worth less than R200 million – if you multiply the number of shares by the market value of each share you can calculate what the company is worth.

This is a simple but effective measure.

These smaller companies are not always analysed and followed by the big institutions, so this is an area where the small investor has a distinct advantage.

Secondly, these companies are often found in the “hi-tech” or electronics sector of the Johannesburg Stock Exchange.
An example which springs to mind is EOH but this share has had its run. But growth companies are not limited to this sector. City Lodge was an example in the Beverages, Hotels and Leisure sector and Coronation Holdings in Banks and Financial Services is still a growth story.

WATCH OUT

These shares are often “high flyers” and can be volatile. If a highly rated growth share disappoints the investing public it can have a devastating effect on your portfolio. The trick is to discover these little treasures before anyone else.