What is a growth industry?
A growth industry is the sector of an economy that experiences an above-average growth rate relative to other sectors. Growth industries are often new or pioneering industries that did not exist in the past. Their growth is the result of demand for new products or services offered by companies in the field. An example of a growing industry is the technology sector, whose products have become smash hits with consumers and have led to multi-billion dollar valuations for tech companies on the stock market.
Understanding Growth Industries
Several factors are responsible for catalyzing a growing industry.
One of them is the advent of new and innovative technologies that can inspire entrepreneurs and startups to develop new industry-related products and services. Given the ever-changing nature of technology, the logic behind investing in these technologies is the promise of exponential future growth.
The smartphone industry, which combined several innovative technologies in a single phone, became a growth industry at the beginning of this decade. Recently, virtual reality (VR) and machine learning are two examples of such an approach. Virtual reality is an immersive computer-generated scenario that can simulate a real-life experience. It has applications in many industries, from VR headsets for gaming to simulations for driving tests and for learning in medical schools.
Big data involves the processing of large amounts of data for research purposes or to identify trends and statistical probabilities. Big data companies provide services to large companies or industries, such as healthcare. Startups and companies in the sector have multiplied as technology becomes more democratic. Investors typically value companies at a multiple of their current earnings and future growth potential.
Regulatory changes can also stimulate growth. For example, the growth of the healthcare sector is mainly driven by changes in insurance regulations. Deregulation of electricity markets and greater awareness of sustainable living have also led investors to put their money into stocks for solar companies and renewable energy companies. Medical marijuana is another growing industry that has sprung up due to the relaxation of strict marijuana laws.
Tesla Inc. (TSLA), which is among the highest valuations of car manufacturers, is an example of a company that benefits from changing regulations and its technological advantages. Investors have flocked to the company because of its promise of a greener future as well as its cars, which incorporate advanced technology.
A third driver of industry growth is a change in lifestyle and consumer preferences. With more free time and the availability of technology and transportation options, consumers have started to travel more. Travel apps and websites have proliferated. Travel-related startups, such as Airbnb and Uber, have achieved record valuations in private markets and are considered hotspots for public markets.
Key points to remember
- Growth industries are sectors of economies that experience above-average growth due to new technologies or changes in societal preferences or government regulations.
- Although these can be volatile and risky stocks, companies in growth sectors usually come with ever-increasing hype and sales numbers.
- Analysts use the CAGR to assess growing industries.
Characteristics of growth industries
Special characteristics of growing industries include companies in an industry with consistent and rapidly growing sales figures and an influx of investment. This can often be accompanied by a lot of hype. Growth industries tend to be made up of relatively volatile and risky stocks. Often, investors are willing to accept increased risk in order to participate in potentially large gains.
Additional risks posed by growth industries can include high rates of cash burn, lack of profitability despite consumer and investor enthusiasm, bubbles and technology setbacks that can impede progress.
Growth Industries and CAGR
Many analysts use the compound annual growth rate (CAGR) to determine the current viability and future potential of an investment. CAGR is the average annual growth rate of an investment over a defined period of time greater than one year and can be applied to companies in growing and steady industries.
To calculate the compound annual growth rate, analysts divide the value of an investment at the end of the period by its value at the beginning of the period. The analyst then raises the result to the power of one, divided by the length of the period, and subtracts one from the following result:
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\text{CAGR}=\left(\frac{\text{Final value}}{\text{Initial value}}\right)^{\left(\fracInstagram{\#\ \text{of years} }\right)}-1 CAGR=(Starting valueFinal value)(# years1)−1
CAGR is widely used to calculate the average growth of an investment. An investment can increase by 6% in one year, decrease by 3% the following year and increase again by 2% the following year. With erratic annual growth, the CAGR can be used to give a broader picture of an investment’s progress; however, it does not take into account external factors such as market volatility.
Example of a growing industry
The marijuana industry has become an example of a growing industry in recent times. Marijuana had a bad reputation and its possession and use was heavily regulated in the country. The situation has changed over the past decade as a wave of popular opinion has led lawmakers to alter their prohibitive stance on the plant. As of August 2022, 37 states have legalized medical marijuana, and its use and possession are legal in 19 states. Universities are conducting research on its uses and applications to medical science. For example, New York University researchers are using it to treat incoming veterans with PTSD. Food entrepreneurs and beverage companies infuse their products with marijuana-based chemicals. Investors poured money into marijuana companies on growth expectations for the future.