Here’s how to spot the best growth investments for your portfolio.
Growth investments involve buying shares of companies that have above-average growth prospects. These are firms whose earnings growth has been above the market average, and are likely to remain above average. Typically, they pay small dividends or none at all. Instead, they re-invest their cash flow in the business, to promote their growth.
Although these stocks can be highly volatile, they often make good long-term investments. They may be well-known stars or quiet gems, but they do share one common attribute—they have grown at higher-than-average rates within their industries, or within the market as a whole, for years or decades.
Two fundamental factors to help you select the growth stocks with the best prospects—and avoid mistakes that can kill your profits
Growth stocks that sizzle
The best hot growth stocks rise above the market and stay above it for years. Others turn cold all of a sudden. When you know the difference you can set yourself up for big profits. Our new free report shows how—and gives you four top growth recommendations.
1. Know the difference between momentum stocks and growth stocks: It’s very easy to confuse growth stocks with momentum stocks. Like growth stocks, momentum stocks often move up faster than the market averages. But momentum stocks attract a different kind of investor. Growth-stock investors are in for the long haul, while momentum investors aim to profit from short-term trades. Momentum investors are particularly keen to jump in on a so-called “positive earnings surprise.” That’s when a company outdoes brokers’ earnings estimates.
Momentum investors see a “negative earnings surprise” (or lower-than-expected earnings) as a sell signal. They use a number 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. However, they also leave at the same time, and that can sharply drive down share prices.
2. Buy growth stocks—But adding value stocks can lower your portfolio’s volatility: Most successful investors will hold some growth stocks and some value stocks at any given time, depending on where they discover the best opportunities.
Value stocks are stocks trading lower than their fundamentals suggest. They are perceived by many investors as undervalued, and have the potential to rise. Many technology stocks, for instance, start out as growth stocks and transition into value stocks.
Together, growth stocks and value stocks can form a winning combination. A growth stock can be a top performer while the company is growing. However, a single quarter of bad earnings can send it into a deep, though 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 rising sharply when investors discover their true value.
Hold a mix of growth investments and value stocks—but as part of a balanced portfolio.
If you take account of your own financial and personal circumstances and temperament, and if you invest as we advise (diversifying across most if not all of the five main economic sectors, while confining your investments mainly to well-established companies), you will automatically buy some growth stocks and some value stocks; you will also automatically buy some small-company stocks and some big-company stocks. However, the economic-sector diversification and overall investment quality of your portfolio are far more important than the relative amounts you invest in value, growth and small stocks.
Most successful investors own some growth stocks and some value stocks at any given time, depending on where they see the best opportunities. By combining growth and value in a portfolio, you can achieve good results while holding down volatility.
Most important, though, we feel most investors should hold the bulk of their investment portfolios in securities from well-established companies. All these stocks should offer good “value”—that is, they should trade at reasonable multiples of earnings, cash flow, book value and so on. Ideally, they should also have above-average growth prospects, when compared to alternative investments.
For stock-market investors, this means holding a total of 10 to 20 mainly well established, dividend-paying stocks, chosen mainly from our average or higher ratings and spreading their holdings out across most if not all of the five main economic sectors.
Do you have growth investments in your portfolio? How have they performed? Share your experience with us in the comments.
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