Growth, or the perception of it, is arguably the biggest driver of share prices. So what is a growth stock?

The Organisation for Economic Co-operation and Development (OECD) defines a growth business as a company of 10 or more employees that grows revenues by an average of more than 20% per year for three consecutive years.

‘That sounds like a good enough definition,’ says Lorne Daniel, an analyst at stockbroker FinnCap.

‘We like to see a strong track record as it is an indication of quality,’ adds Mark Slater, founder of asset manager Slater Investments and primary manager of the Slater Growth Fund (GB00B7T0G907).

But like any investor, Slater has his eyes firmly fixed on future potential rather than historic performance.

‘A business with a great track record that has come to an end is of no interest,’ the fund manager says. ‘Twenty per cent growth rates are much rarer now than 10 or 20 years ago but our favourite companies are able to sustain growth rates in that ballpark.’

ALL SHAPES AND SIZES

Growth companies come in all shapes and sizes but the dynamic inevitably favours smaller companies. A business with £100m of revenue is far more likely to put up 20% annual growth rates over a three year period than one with £5bn sales.

That is described by what is called the ‘law of large numbers’ where boosting revenue becomes increasingly difficult when sales are much bigger.

It’s not impossible. Technology titans like Google’s parent company Alphabet and online retail giant Amazon have been pulling off this trick for years despite being among the world’s largest companies by market value. The big Chinese internet companies, such as Alibaba and Tencent are doing likewise.

‘I find it extraordinary,’ says Ali Unwin, manager of Neptune Global Technology Fund (GB00BYXZ5N79).

TRUE ARBITER OF GROWTH STATUS

Rapidly expanding revenue is most relevant to investors as a way of driving the share price higher, which arguably makes that the true arbiter of a growth stock.

‘Price is also important,’ says Slater. ‘Great growth companies priced to the sky are of no interest to us. We seek the optimum combination of dynamic growth and a reasonable price, along with a raft of other protective criteria to limit our downside,’ he explains.

Growth investors tend towards the optimistic and are quite capable of chasing share prices to astonishing levels on the assumption of future profit performance. Often profit may be years down the line.

‘Profit is a very different issue from growth,’ says FinnCap’s Lorne Daniel. ‘I’m sure people hope growth leads to profit but that’s been shown as not always the case,’ he says.

New technology is sparking a paradigm shift in business and society that creates opportunities and threats to established organisations. It is also spawning legions of new businesses which are shaking up existing operating models and creating entirely new markets.

GROWTH STOCK CLASSICS

Fast growing companies which are now household names include Uber, Airbnb, Netflix and Tesla. These relatively new businesses are transforming the way we behave and are blazing new trails for us to travel.

While most of those companies aren’t profitable, investors haven’t allowed that to get in the way of the story or the share price in the case of Netflix and Telsa; Uber and Airbnb remain privately-owned, for now.

UK INVESTOR ACCESS

There are plenty of growth companies available on the UK stock market. Examples include attractions and ticketing software designer Accesso (ACSO:AIM), health, safety and regulations kit maker Halma (HLMA) and cyber security specialist Sophos (SOPH).

Others include property website Rightmove (RMV), IT consultant FDM (FDM) and Alfa Financial (ALFA), the asset financing software expert.

Allianz Technology Trust (ATT) and Polar Technology Trust (PCT) are specific technology investment collectives which provide exposure to lots of growth companies.

Find out how to deal online from £1.50 in a SIPP, ISA or Dealing account. AJBell logo

Issue Date: 27 Dec 2017