How to identify high-quality large growth stocks? And how to determine valuation and seize opportunities?

Futubull Classroom conducted a small survey in the Futubull community and found that more than half of the people preferred growth stocks for different types of stocks.

Looking at the data, from the opening on January 1, 2012 to the close on January 1, 2024, the growth stock index ETF of the S&P 500 (IVW) increased by about 454%, with an average annual growth rate of about 15%. During the same period, the S&P 500 index (.SPX) increased by about 310%, with an average annual growth rate of about 12.48%.

Simply looking at this data, it is not difficult to understand why many investors prefer growth stocks.

But preferences are one thing, and specific investment strategies are another. When it comes to growth stock investment, there may be many questions.

For example: What counts as a growth stock? How to identify high-quality growth stocks? How to judge whether the valuation is reasonable or how to seize the opportunity? How to manage risks and deal with market uncertainty? Here, we will respond to these questions based on Charles F. Henderson's large-cap growth stock investment method.

1. What counts as a growth stock? What are the characteristics of large-cap growth stocks?

Simply put, growth stocks are those companies with high growth potential, which means that their expected profitability and revenue growth rates are higher than the market average.

Such companies in the rapid development stage are usually more common in emerging industries (emerging industries such as AI, electronic information, biotechnology, etc.). However, it is not absolute, and companies in non-emerging industries with innovative business models and technologies may also be growth stocks.

Henderson specializes in growth stocks with a market capitalization of over $2 billion. In his view, such companies not only have sustained growth potential, but also often have stable market positions and good profit capabilities, thus bringing long-term value to investors.

2. How to identify high-quality growth stocks?

When analyzing stocks more specifically, Henderson values four indicators: revenue growth rate, net income growth rate, return on equity (ROE), and asset-liability ratio. He believes that high-quality growth stocks need to perform better than the market average in these areas.

Below is a brief explanation of these four indicators.

Based on the main information in the above chart, let's take Tesla as an example to do a simple analysis and application.

From the perspective of revenue, Tesla's current revenue scale is better than that of BYD, and it has also maintained revenue growth in recent years, especially a relatively high growth rate in 21 and 22. However, Tesla's revenue growth rate has declined somewhat in 23, and BYD's revenue has also shown a growth trend in these years, with a catching-up momentum. There may be some policy and market competition reasons behind this.

From the perspective of net profit, Tesla has also been growing in recent years, especially in 20, 21, and 22, but the growth rate in 23 is a bit weak. In comparison, BYD's net profit in recent years is more volatile, but there is a growth trend later.

Looking at the ROE, Tesla has maintained a level of over 20% from 21 to 23. In terms of the asset-liability ratio, Tesla had some pressure in this area in the previous years, but this indicator was controlled below 50% from 21 to 23.

Based on this information, is Tesla a growth stock? You may have made your own preliminary judgment.

However, more of the analysis above is quantitative. To make more accurate judgments, some qualitative analysis is also essential, including a profound insight into the entire industry. In this regard, perhaps from When looking for growth stocks, it is important to first consider the industry. According to master Phillip Fisher, there are two key tools to consider.I gained some inspiration from this.

3. How do you determine whether the valuation is reasonable and how do you seize the opportunity?

If you have already found some growth stocks, the next question is how to choose the right timing.

In this regard, Henderson uses the investment concept of GARP, which emphasizes both growth and value (focusing on company fundamentals and valuation levels). The PEG ratio is a valuation indicator that is more consistent with this concept.

For example, if the current P/E ratio of TUTU company is 14.5 and the expected annual growth rate of net income in the next 3-5 years is 15%, then the PEG ratio of TUTU company can be calculated as 0.97. In general, this may indicate an undervaluation.

However, predicting the expected annual growth rate of net income requires not only historical growth information, but also a good understanding of the company's fundamentals, and the prediction will inevitably have a subjective element. Nevertheless, it can be compared to the forecasts of management or analysts, or to the industry average.

There are other considerations as well. For example, the absolute value of PEG may not fully explain the situation, and comparing it with other companies in the same industry is an important consideration. Moreover, market conditions can also have an impact, as investors may be more willing to accept higher PEG ratios in a bull market and lower ratios in a bear market.

4. How to manage risk and respond to market uncertainty?

After selecting high-quality growth stocks and judging the entry and exit timing based on fundamental and valuation analysis, one's investment is not complete. The following are a few tips to better manage investment risk. Although it may sound like a cliche, it is indeed a very important part of investing.

Diversification can help reduce risk: the screening of growth stocks is not easy, so it is necessary to reserve some room for error and maintain awe of the market. If diversified investments can be made in multiple industries and companies, the potential for losses due to personal inadequacies or market changes can be reduced. In terms of diversified investment, relevant ETFs provide a choice. You can learn more about ETFs in the class entitled, The ETF Strategy Guide from Beginner to Advanced.

Long-term investment with patience: based on the above methods, the screened companies are expected to have long-term growth potential. If you exit quickly due to short-term market fluctuations, you are likely to miss long-term growth opportunities.

Regular reviews and flexible adjustments: since the market is constantly changing, some holdings may gradually become unsuitable for your standards, so regular reviews and flexible adjustments are needed. For example, removing positions that perform far below expectations and adding positions with more growth potential. This may involve some stop-loss and stop-profit strategies, which you can learn more about in When to Sell Stocks: 7%-8% Stop Loss Strategyand When to Sell Stocks: 20%-25% Stop Profit Strategy.

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