Growth shares are known for their explosive potential. And while many fail to live up to expectations, a few go on to deliver monstrous returns. In fact, there have been a few instances like Netflix and Shopify where a £1,000 initial investment grew beyond £10,000 within a few short years.
Obviously, hindsight is 20/20. Finding these sorts of investments before they take off is far easier said than done. After all, a lot has to go right to enjoy a 1,000% return. And while there’s no denying that luck can play a role, each success story throughout history shares some common early signs of potential success.
Picking winning growth stocks
Stock picking is a complex process that involves a lot of nuances. However, before dissecting the financial statements and diving deep into the weeds, investors seeking quadruple-digit returns need to allocate their time wisely.
There’s little point in investing countless hours evaluating an industry titan if they’ve already reached, or are nearing, their maximum growth capacity. Investors need to examine what a business does and try to estimate how large its total serviceable market will be over the next decade.
Moreover, they need to determine the group’s ability to capitalise on this opportunity. Small-cap stocks can be a wonderful area to find exciting enterprises. However, many lack the financial resources or expertise to outpace existing industry giants who tend to keep tabs on disruptive threats.
Personally, when looking for such firms, I tend to pay attention to the level of revenue growth. Seeing a high double-digit expansion of sales can be a signal to pay closer attention. I’m also looking closely at cash flow. Suppose a business can generate all the cash it needs internally? In that case, it reduces the risk of equity dilution as well as the need to take on unnecessary debts.
However, above all else, an encouraging performance needs to be backed by sustainability. When looking at previous winners, organic growth from repeating sources led to the most value being created for shareholders. By comparison, growth from acquisitions, on average, actually led to the destruction of value, resulting in underperformance.
These are obviously not the only critical factors investors need to consider when picking growth stocks. But they can help eliminate duds from consideration.
Alternative solutions?
Stock picking paves the way for explosive market-beating returns. But it also comes with added risks that might make it unsuitable depending on the individual. After all, it often comes paired with significantly higher volatility versus a low-cost index fund.
Fortunately, the latter also provides a path to a 1,000% return in the long run. For example, the FTSE 250 has historically provided investors with an average of 11% total returns a year since its inception. Providing this growth continues, a £1,000 investment could be transformed into £10,000 in just over 20 years.
This timeline is only an estimate. And it may end up taking longer if the UK’s flagship growth index starts to slow in the future. That’s why I personally prefer the idea of picking individual stocks despite the added risks and volatility exposure.
