5 things to look for when seeking out growth stocks

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Now that you know what a growth stock is, you wouldn’t be alone in deciding that you want to find some to invest in. After all, who didn’t get major investing FOMO after hearing about those who got in early with Amazon (NASDAQ:AMZN), Shopify (TSE:SHOP), or Tesla (NASDAQ:TSLA)?

Growth stocks—small companies that are expected to rise at an above-average rate—are every investor’s dream. But how exactly do you actually find high-growth companies? Do you just have to hope you run into someone with a hot tip? Do you have to be able to decipher complicated charts?

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There isn’t one secret surefire strategy to find growth stocks, otherwise everyone would be millionaires. Rather, finding growth stocks involves a combination of learning about the stock market, developing your analytical skills, and knowing how to recognize trends when you see them.

Just know that finding growth stocks isn’t easy, but that just makes it more rewarding when you do find one.

A strong balance sheet

One of the ways to see if a company has growth potential is to look at its financial fundamentals. Start with assessing a company’s balance sheet, which will show you the company’s income, capital, and assets within a certain time period (monthly, quarterly, or annually).

A good growth stock’s balance sheet will show you a good cash position and low to manageable amounts of debt. You don’t want to go investing in a hot growth stock only to find out the company used a massive amount of debt to get ahead.

An impressive income statement

The income statement, aka profit and loss statement, is one of the most important indicators of what a company is doing with its money and how successful its financial performance has been. It will show potential investors what it has made in revenue, as well as its profits and losses, expenses, and net income.

An income statement is essential to gauge the financial performance of a company, and also highly useful if you are trying to compare the financial performance of two companies, as the side-by-side analysis will give context into which is performing better.

High cash flow

Another thing to look out for is cash flow. How cash is flowing in and out of the business and how sustainable that has been over time can be a great indication of the company’s ability to make profits, manage debt, and essentially grow as a business.

Growth stocks will usually have low or negative free cash flow because they need to reinvest most of their capital. Instead, look for operating cash flow that is showing consistent growth.

Analysts give the green light

When in doubt, always consult the experts. A company might have an incredible balance sheet, stellar income statement, and great cash flow, but it also needs to be projected to grow its earnings.

Having analysts predict growth in a company’s earnings is a great way to feel good about a growth stock. That said, although they can point you in the right direction and you shouldn’t ever use analyst’s ideas as your only guide, as they are never 100% accurate.

It’s disrupting an industry

It might sound obvious, but another great way to find a growth stock is to find a company solving a problem that no one else has yet. Look out for companies that are filling a niche field—like how Uber (NYSE:UBER) solved the problem of people frustrated with unreliable and expensive taxi rides, or how Shopify allowed small business owners to have an online platform to sell their products.

If there are multiple companies competing to solve the same problem, you can compare each one’s finances to see which is likely to outperform the other. It’s usually obvious which one will be the frontrunner, but some signs of future success are a loyal customer base and if the company is dedicated to researching and developing the business.

Finding the next big growth stock is always going to be a challenge, but by doing some digging into a company’s financial performance, seeing if it’s a leader in an emerging field, and getting the go-ahead from the experts, you’re much more likely to find one.

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