A company, just like a product, has a life cycle. Understanding that life cycle might enable an investor to buy into the right companies at the right times and build a strong, diversified core of optimized stocks. These are what Benjamin Graham, in his book The Intelligent Investor, refers to as “carefully chosen growth stocks”—stocks expected to grow at an above-average rate.

Here’s how enterprising investors can use the company life cycle to potentially find growth stocks:

1. Understand the Stages of a Company’s S-Curve

If charted on a graph, a company’s life cycle looks like an elongated and flattened “S.” The curve begins sloping upward to the right, showing modest, shallow growth as a small number of early adopters embrace the company and its product.

This is followed by a rapid acceleration that causes the slope to curve sharply upward until it reaches its maximum growth rate, where the company or product sits in a dominant market position. Here growth slows and the “S” begins to plateau as the market matures. At this stage, the company might maintain its high performance, but see little growth due to market saturation or competition.

2. Recognize Potential Growth Companies

Companies that continue to grow do one thing exceptionally well: innovate. The time for innovation is right when upward growth begins to taper, but a growth company won’t wait until growth slows to begin the next round of innovation. They make innovation part of their company culture and use the S-Curve as a strategic tool to help them sustain an upward trajectory.

Top growth companies actively seek customer insight, and use this insight to inform the development of new products and services. They time a new product or value proposition—a new S-Curve—to hit its accelerated growth curve at the same moment that the previous growth strategy plateaus. They employ experts, target potential high-growth markets, court new markets, and create opportunity.

3. Know When to Jump In

A company’s life cycle may be a one-time or recurring phenomenon, depending on the nature of product or service the company offers. Stock prices are typically lowest at the start of the S-Curve and often highest near the top, meaning that the stock prices of revenue growth companies usually rise fast. Therefore, investors can use revenue growth to gauge a company’s position along the S-Curve.

Companies moving from $2 billion in revenue to $3 billion in revenue, as well as those posting little or no revenue growth, are already mature (top of the “S”). Their stock prices may be high, and may rise slowly. Companies moving from $100 million to $2 billion in revenue in four to six years are in the accelerating stages of growth (the steep upward slope of the “S”). Stock prices often start low and rise rapidly. Many companies go from $100 million to $1 billion within four to six years. The difficulty lies in buying stock early and not overpaying for them based upon good valuation metrics, not just Price to Earnings (P/E). Valuation metrics should also include Price to Sales (P/S), Price to Free Cash Flow to the Firm (P/FCF), and Price to Book Value (P/B).

These are your growth stocks. Understanding the S-Curve may help you to find, buy, and sell these stocks at the optimal time. You’ll want support throughout this process. Choose an investment advisor who is able to screen and find many of these types of companies – and one who is energized and empowered by this challenge.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.

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