Most folks think “growth investing” is all about finding companies that are increasing their revenue (or sales) at a rapid rate.

But there’s a lot more to it than that.

Not all growth is created equal. Two companies can grow at 50% annually, yet one is destined to become the next Amazon while the other is poised to implode like WeWork.

The difference isn’t the speed of growth… it’s the quality of growth.

You must find the right kind of growth to be successful. That’s sustainable “healthy growth.”

“Fragile growth” on the other hand is an unsustainable investor trap.

Learning to tell the two apart can mean the difference between a lifetime of success and devastating losses.

Let’s look at a super simple example so you can understand what I’m talking about:

Imagine two kids in your neighborhood—Emily and John—both start lemonade stands.

Emily starts by perfecting her recipe. Customers love it and come back every day, demonstrating robust real demand for her product. She charges $2 per cup, and each cup costs her just $0.50 to make (lemons, sugar, cups).

That’s $1.50 profit per cup. She reinvests her profits to get a better stand, a cooler for ice, and a sign. Her costs per cup stay around 50 cents even as she sells more. Within months, she’s selling 100 cups a day, making $150 in daily profit. Her business gets more efficient as it grows.

John starts his lemonade stand by giving away free cups to “get customers.” Then he charges just $1 per cup to undercut the competition from Emily and boost his sales volume, but he spends $3 per cup using fancy imported lemons, expensive organic sugar, and hiring his friends to hand out flyers.

John’s stand is growing fast and has tons of customers, but he loses $2 on every sale. His parents keep giving him money to “scale up,” assuming he’ll eventually figure out profitability. But he never does. And John’s stand collapses when his parents stop funding the losses.

While simple, I think this example captures the essence of what separates great growth stocks from bad ones. Emily’s stand has positive unit economics—she makes money on each transaction and gets more efficient with scale. John’s stand has negative unit economics—he loses money on every sale and scale amplifies the losses.

It may surprise you to learn that many billion-dollar companies operate just like John’s lemonade stand.

Now, let’s get specific about what to look for when evaluating the quality of a company’s growth.

Three of the biggest red flags indicative of “fragile growth” that I look for are:

1. Cost of goods sold (or COGS, also called cost of revenue) growing faster than revenue

2. Sales and marketing expenses growing faster than revenue

3. A CEO with a “growth at all costs” mentality

Red flag #1: Cost of goods sold growing faster than revenue

COGS growing faster than revenue may be the most critical warning sign, but many investors still miss it.

Cost of goods sold represents the direct costs of producing what you sell. For a software company, it’s basically server costs and customer support. For a retailer, it’s the wholesale cost of products. For a manufacturer, it’s raw materials and production labor.

In a healthy, scalable business COGS should grow slower than revenue—meaning gross profit margin improves—as it achieves economies of scale.

When COGS growth consistently outpaces revenue growth, something is fundamentally broken. The company’s products are priced too low and/or cost too much to make so it’s losing money on every sale. This can happen because of things like:

  • Aggressive price discounting to drive growth

  • A lack of pricing power due to a weak moat or cutthroat competition

  • Operational inefficiencies that get worse with scale

  • An unscalable business model that requires too much custom work for each customer

Red flag #2: Sales and marketing expenses growing faster than revenue

Acquiring customers is expensive. But a healthy growing business retains the customers it already has—which is at least 5X cheaper than acquiring new ones and up to about 30X cheaper—and becomes more efficient acquiring new customers over time.

So sales and marketing expenses should decline relative to revenue as a company matures.

When a company needs to spend more and more on something like advertising to attract each new customer, it’s running out of easy customers. The market may be getting saturated. The company’s product may not be compelling enough. Or competition may be forcing the company to spend more to stand out.

Red flag #3: A CEO with a “growth at all costs” mentality

Some CEOs become intoxicated by growth, viewing it as the ultimate validation rather than a means to maximize long-term profits. You can spot this mentality in their behavior and their financial decisions.

The warning signs of this mentality include things like:

  • Obsessive focus on “total addressable market” and market share rather than profitability

  • Aggressive debt-fueled acquisitions of peers

  • Frequent shifts in strategy to chase new trends

  • Promotional language in shareholder letters

  • Compensation tied purely to revenue growth, not profitability or cash flow

  • Subsidizing products at unsustainable prices to “capture the market”

  • Creating misleading metrics to hide underlying problems

One of the best examples of this red flag is WeWork under CEO and co-founder Adam Neumann. WeWork grew like crazy from 2010 to 2019 and reached a valuation of just under $50 billion. But it was all an illusion—a house of cards built on burning cash and a broken business model.

WeWork would lease office buildings (or large portions of them) on a long-term basis (10 to 15 years), then subdivide the space into flexible work areas and offices and rent it short-term to customers who could leave anytime.

So when a recession came or customers left, WeWork would still owe billions in rent. The unit economics never worked, but the growth story captured countless investors.

Neumann lived lavishly. He bought buildings and leased them back to WeWork (self-dealing) and created weird metrics like “Community Adjusted EBITDA” to try to make losses look better.

The company called itself a “technology platform” to justify a lofty tech valuation when it was really just a commercial real estate company with terrible economics.

Investors caught on to this fact when the company tried to IPO in 2019 and the whole house of cards came tumbling down. WeWork’s $47 billion valuation fell about 95% and Neumann was ousted. The company eventually filed for bankruptcy in 2023.

The lesson: Growth without sustainable unit economics is the very definition of “fragile growth.” And CEOs pursuing “growth at all costs” eventually run out of other people’s money to burn.

Related: Stock Dip Can’t Stop Tesla From Dominating Future Tech