Topic: Growth Stocks

3 growth investing tips to boost your investment returns

growth vs value investing

Growth investing isn’t such a gamble if you follow these three tips.

If you meet a large number of investors over a large number of years, it may seem they come in two basic categories—one inclined toward value investing, the other more interested in growth investing.

Value investing entails trying to buy assets at bargain prices. Growth investing tries to identify and buy rising stocks when they have further growth ahead.

If you balance and diversify your portfolio as we recommend, it should include both growth investing and value investing selections. In both areas, you should avoid extremes.

If a stock seems like an exceptional bargain in relation to earnings or asset values, it may suffer from hidden risks. The stock can plunge when those problems begin to take their toll. On the other hand, if a growth investing stock trades at such a high price that it needs exceptional results to move ahead, then it suffers from obvious rather than hidden risk: a single quarter of bad earnings can spark a collapse in its value.

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1. Don’t get caught up in momentum investing

Momentum investors like to invest in companies whose earnings and stock prices are rising. They are largely unconcerned with value considerations such as high p/e ratios or low dividend yields. They don’t care if a stock trades at 50 or even 100 times earnings. They assume that the company’s earnings and sales will continue to rise 15% to 17% a year, on average, as they have in the past five years, and that the stock price will do the same.

Momentum investors are keen on the so-called “positive earnings surprise,” when a company outdoes brokers’ earnings estimates. They view a “negative earnings surprise” —lower-than-expected earnings—as a sell signal. They use a variety of formulas to make buy and sell decisions, but all come down to “buy on strength and sell on weakness.” So they tend to pile into the same stocks all at once, and the gains that follow are something of a self-fulfilling prophecy.

Most successful investors own some growth stocks and some value stocks at any given time, depending on where they see the best opportunities. The two can make a good combination. Growth stocks can be top performers when the company is in fact growing. However, a single quarter of bad earnings can send a growth stock into a deep but often temporary slide. Value stocks can test your patience by moving sluggishly for months if not years. But they can make up for it by suddenly shooting up when their true value is discovered through the tapping of hidden assets or some other manner.

If you look at a list of top-performing mutual funds or investment advisors, you’ll often find momentum investors at the top of the list for periods of one year. But it’s a hard act to maintain. A year later, you’ll often see a different set of momentum investors at the top of the one- year top performers list.

In contrast, if you look at a list of top performers over a period of a decade or two, the top spots usually belong to people who invest much as we do – who look at all the excruciating detail and temper it with a consistent blend of diversification and common sense.

2. Hidden assets can make a world of difference long-term

We’ve talked about hidden assets in previous posts; they can make a huge difference in growth stocks in the long term. One example of a company’s hidden assets would be real estate. When a company buys real estate, the purchase price goes on its balance sheet as the historical value of the asset. Over a period of years or decades, the market value of that real estate may climb substantially. But the purchase price remains unchanged on the balance sheet.

You have to look closely to spot this hidden value. At times, the hidden value in a company’s real estate can come to exceed the market value of its stock. This hidden value may only become apparent to investors when the company upgrades the use of the real estate. For example, a merchandiser might repurpose a parking lot to build a shopping mall with a residential condo tower on higher floors, and a parking garage down below.

Another example of hidden assets is research and development spending. Technology companies spend large sums of money developing new practices and technologies that can change the world of the future. This research may not pay off for decades, but if you’re a keen investor, you can see what companies spend on research and development via their income statements.

The best time to find hidden assets is when they’re still hidden, long before the company begins taking steps to profit from them. Understanding and seeking out hidden assets while you’re evaluating a stock can add enormously to your profits in the course of an investing career. But you need the patience to profit from them because they can stay hidden for a long time after you buy.

Hidden assets can also cut your risk. Stocks with hidden assets are likely to hold up better than those whose assets are easier to spot since they are the last stocks that experienced, successful investors sell. When times are good, on the other hand, stocks with hidden assets tend to do better than average. Good times give them opportunities to put their hidden assets to work.

High debt hurts growth

When you’re researching growth stocks, you need to know how much debt they’re holding. Growth companies with a lot of debt have a hard time recovering from an economic downturn.

The more manageable the debt, the better. When bad times hit, debt-heavy companies often go broke first. Especially ones that also keep trying to allocate part of their cash flow to paying dividends

Aim for steady—not outsized—returns

You can’t expect to earn an outsize return indefinitely. If you did, you’d wind up with a measurable fraction of all the money in the world, and nobody ever does that.

Regression to the mean is inevitable. No investor and no investment can earn an outsized return indefinitely. Eventually, a high yearly return will come back down toward average.

Has this article given you more perspective to the practice of growth investing? What are some of the challenges you’ve faced along the way? Share your thoughts and ideas with us in the comments.


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