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Demystifying Growth Investing Strategy

The recent surge in inflation, global political risks, and monetary tightening expectations are creating havoc in the equity markets, especially with growth stocks dropping significantly from their recent peaks

Published OnJanuary 10, 2023Updated OnAugust 1, 2025
Author: Syed Mustafa Nadeem, CFA

The recent surge in inflation, global political risks, and monetary tightening expectations are creating havoc in the equity markets, especially with growth stocks dropping significantly from their recent peaks. At this time, I believe it is important to reiterate the basics of the Growth Investing Strategy; how to put a value on growth, as to be able to differentiate it from overvalued investments.

Growth Investments are characterized by paying a premium on the current valuation considering the future potential in the business. Simply put, a growth investor is expecting the valuation to become attractive in the future based on the forward multiples. In this article, I discuss four parameters to identify Growth Investments in public and private markets.

Parameter 1: EV/Revenue

For this parameter to be into play, the revenue of the company must be growing significantly such that by the end of the reference period, the EV/Revenue aligns or becomes cheaper as compared to the industry benchmarks. This is possible under the below scenarios:

Since we have to account for forecast risk in the investment thesis, scenario 1 is most likely to justify an investment to be categorized as a growth investment. In scenario 2, the incremental revenue is coming from both an increase in market size and market share. Therefore, the forecast risk increases as now we are considering an additional variable of market share gain in the incremental market size. Similarly, scenarios 3 and 4 have the highest forecast risk as we have added the variable of outperforming the competition which, in most cases, is unlikely.

Parameter 2: EV/EBITDA

A company may also be categorized as a growth investment if its EV/EBITDA shows a declining trend in the forecast horizon. The EBITDA can grow primarily because of two reasons. Increase in revenue and operational efficiencies.

Parameter 3: P/E

Earnings growth is one of the more traditional indicators of growth stocks. Earnings growth can come from both revenue and EBITDA growth, in addition to a decline in interest or tax burden. While we have discussed the classification of revenue growth and EBITDA growth previously, we will focus on reducing the interest burden for firms with a high degree of financial leverage. Interest burden can primarily reduce because of:

It is a good practice to use the PEG ratio with expected earnings growth to differentiate growth stocks from overvalued stocks. However, both P/E and PEG have become unpopular recently because in some cases either the firms are not expected to become profitable in forecast-horizon or alternative parameters (EV/Revenue or EV/EBITDA) are more suitable for valuation.

Parameter 4: P/FCF

A company can become attractive based on the current price and future free cash flow (P/FCF) when there is an increase in EBITDA, reduction in working capital requirements, and/or reduction in recurring CAPEX. While we have discussed EBITDA with the above parameters, both working capital and CAPEX can be projected with a high level of accuracy provided the analyst is aware of business fundamentals. A company showing a significant decline in P/FCF on a forward basis may also have the possibility of higher payouts (dividend story) and deleveraging. Robust FCF generation may also mean there are not enough avenues for businesses to invest in the future countering the growth argument. However, as of today, that still implies it remains a growth story on the P/FCF parameter.

Differentiating Growth from Overvalued Investments  

Simply put, a growth investment would fit in any of the above 4 or multiple parameters. On the other hand, it will be difficult to attribute an overvalued investment to any of the above parameters or will have significant forecast risk.

Things to Lookout For:

Remember, Rate hikes, inflation, and wars are all temporary but the Growth Investing strategy is forever. Hope you enjoyed reading. Please feel free to share your feedback.

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