Earnings-Driven and Revenue-Driven Managers

The majority of growth managers are earnings-driven, which means they use a company's earnings as their yardstick for growth. If a company isn't growing significantly faster than the market average or its industry peers, these managers aren't interested.

Earnings-driven: The momentum managers

Within this earnings-driven bunch, momentum managers are by far the most daring. Momentum investors buy a rapidly growing company that they believe will deliver a quarterly earnings surprise or other favorable news that will drive the stock's price higher. Managers who follow this style try to buy a stock just prior to a positive earnings announcement (that is, when a company announces that its earnings are higher than Wall Street analysts predicted) and sell it before it misses an estimate (that is, when its earnings fall below what analysts thought they would be) or has other negative news. Momentum managers pay little heed to stock prices. Their funds, therefore, can feature ultra-high price multiples. They also tend to have high annual turnover rates, which can make for big capital gains payouts and poor tax efficiency.

Some managers seek earnings growth in a different way. Instead of searching for stocks with the potential to surprise during earnings season, these managers seek stocks that boast high yearly growth rates: generally between 15% and 25%. But like momentum investors, managers who employ this strategy typically ignore stock prices, so their funds' price multiples can be sky-high. This investment style also encourages high portfolio-turnover rates. Although this strategy is different in principle from momentum investing, the results are often similar.

The most moderate earnings-growth-oriented managers look for stocks growing in a slow but steady fashion. The slow-and-steady group usually buys blue-chip stocks. As long as these stocks continue to post decent earnings, slow-and-steady managers tend to hold on to them. Steady-growth funds often have more modest price ratios than their peers. But when reliable growers take the lead, these funds endure as much price risk as the more aggressive funds.

Revenue-driven

Of course, not all growth companies have earnings. In particular, younger companies may be unprofitable for years until their businesses reach critical mass. Some growth managers will buy companies without earnings if the companies generate strong revenues. (Revenues are simply a company's sales; earnings are profits after costs are covered.) Because there is no guarantee that firms without earnings will ever turn a profit, this approach can be risky.