Growth investors invest in stocks that have higher-than-average return potential compared to other stocks in the market. That means growth investors use criteria such as revenue growth, earnings growth, return on equity, and return on invested capital, among other metrics, to inform their investment decisions. These criteria can be augmented by strong management that is skillful at capital allocation, such that those managers can maintain high growth rates for as long a period as possible.
The law of large numbers often means that growth stocks’ compound returns do lower over time, and so the once high-growth achieved by those growth stocks can stall. That is why growth investors tend to allocate their money into new growth stocks that should experience high multiple expansions into the future, at least until they, too, face an abatement in high growth compound returns.
The risk inherent in growth investing is that growth investors can “chase hot stocks,” effectively buying high and selling low, or simply rack up high commission fees from a higher-than average turnover in their portfolio. The risk/reward concept argues that growth investors are rewarded for their assumption of greater risk in the market. Usually, growth stocks exist in the micro-cap, small-cap, and mid-cap segments of the market, because as previously mentioned, growth stalls due to the law of large numbers (that is, compounding returns can’t be high forever). Eventually growth stocks can become large “steady” stocks.