Identifying businesses with strong growth potential is the objective for most investors but finding these exciting opportunities before others can be difficult. By running through a checklist of criteria for spotting the right business for your investment needs, you could support a startup and help it to thrive while also reaping your own financial rewards.
The right idea
A business with untapped potential needs to have the right idea and according to financial expert Professor Raffi Amat, must offer products and services “that add value” for customers rather than just existing to offer new tech. If they are adding value, they are solving a problem or filling a gap in the market and are more likely to appeal to a larger addressable audience immediately.
To identify a problem solver, you should try to find businesses that have a business plan featuring solid financial projections and a clear roadmap for how it intends to implement a solution the market wants at scale, and cost-effectively. Ideally, you want your investment to drive growth and expansion for a company that already has robust fundamentals in place and is appealing to customers.
The right characteristics
Renowned American stock investor Philip Fisher outlined the criteria for spotting a growth company in his critically acclaimed book, Common Stocks and Uncommon Profits. His advice still rings true six decades on. He recommends targeting companies that:
- Can deliver sales growth in the long term
- Can generate high and sustainable margins
- Has a strong executive team
- Has a culture that is steeped in “moral responsibility” to customers, and eventually shareholders.
On the concept of growth, he adds: “An organization which in relation to the size of its activities has produced a good flow of profitable new products will probably be equally productive in the future as long as it continues to operate under the same general methods.”
Understand how your investment will help
A business might have potential, but it will be very difficult for you to realize it if your investment won’t be sufficient to build a platform for success. Two-thirds of entrepreneurs admit their startups face potential failure within two years of trading, which highlights how good ideas don’t always translate into success. You might find a business with the right product and want to be the first to invest, but you need to make sure that others will eventually spot its potential.
Being able to conduct due diligence for a potential investment, even when it looks lucrative on the surface, is key if you want to make smart decisions. This is an area in which Solitude Capital, a leading investment management company, has excelled in during the last decade. As chief information officer, Joel Werner ensures Solitude allocates funds to the right mix of emerging growth companies. While you are unlikely to have the same level of support as an investment firm, you can still make wise investment decisions by thoroughly researching a company and using hard data to identify and act on the best opportunities.
Identify types of growth
You want to invest in a growth company but are you sure that the untapped potential can be realized or sustained in the long term? For example, a company in an industry that is highly regulated and very competitive may struggle to become a market leader and its growth may be impacted as a result. You should also try to determine whether a company’s growth prospects are “real” and borne out in earnings reports. In today’s more volatile economic climate, investors are looking more closely at cash flow as having cash at hand is vital for business continuity.
Consider global expansion
A new company may only be trading in a single, regional market but you could unlock its potential if you believe it can take its existing products to new markets, which may be a better fit. Looking to expand globally can deliver more reliable results than trying to drive growth through new ideas and products which may be costly to research and produce and then potentially fail. Finding opportunities first means looking for avenues and channels that you think a business can exploit to its advantage that others might not have seen.
Find out what customers think
A new business might not have set the world alight in terms of profit and revenue, but it could be underrated if its employees, customers and suppliers view it very favorably and believe it offers an excellent service or experience they cannot get elsewhere. This is what Fisher called the “scuttlebutt” approach where investors don’t obsess over raw numbers and instead try to understand how a business works and what it could potentially do for the world. Finally, Fisher recommends finding great businesses, not overpaying in terms of investment and using expertise to turn a bright prospect into a long-term success story.