The Danger of Being a Growth Investor
Investing can be extremely boring, or it can be extremely exhilarating, depending on the type of investors you speak to. Investors who find it exciting could most likely be growth investors. This is because growth investors are the ones looking for fast-growing companies that have the potential to change an industry completely.
Moreover, searching for these companies and learning about the development of these industries can be an exciting endeavour. However, being a growth investor can also be quite risky. Although growth investing could bring us outsized returns, it is important for us to be aware of the risks associated with it as well. Here are two risks we need to be mindful of.
Building Growth By Stacking Risk
When we come across a fast-growing company, we have to dig deeper into how the growth will come about. If a company is growing by adding more and more debt onto its balance sheet, it could be a sign of trouble. For example, during the oil and gas boom a few years ago, many of the oil and gas companies in Singapore were financing their growth through debt. However, when the industry turned for the worst, many were caught with a mountain of debt, together with declining revenue. Today, many of these companies are facing bankruptcies.
Therefore, we would want to stay clear of such companies and not mistaken their growth as “sustainable growth”.
Secondly, a company can be enjoying a high-growth period, and the minority shareholders may still not enjoy the rewards of this growth. This is because minority shareholders depend greatly on the honesty of the management to treat them fairly.
If the management of a company has questionable motives, it can choose not to distribute the growth to minority shareholders through dividends.
Thus, when we are investing in fast-growing companies, it is important to ensure that we trust both the main shareholders and the management of the business.