Topic: Growth Stocks

Top Growing Stocks Can Hurt Your Portfolio Unless You Follow a Sound Strategy

Many top growing stocks look appealing at first, but once you dig deeper into your analysis, a large number turn out to be speculative and entail higher levels of risk than expected.

Most successful investors hold some growth stock picks at any given time (as well as some value picks) depending on where they discover the best opportunities. A growth stock can be a top performer while the company is expanding. However, a single quarter of bad earnings can send it into a significant, though often temporary, slide.

Although top growing stocks have appeal, they also come with varying levels of risk. The Successful Investor approach gives you tips to help you maneuver through this investment area. Here are four of them:

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4 important tips to follow for investing in top growing stocks

Be skeptical of top growing stocks that mainly grow through acquisitions. Making acquisitions can speed up a company’s growth, but it also adds risk that can undermine a safe, conservative investing approach. Great acquisitions are rare finds. Many acquisitions come with hidden problems or risks, or they turn out to have been over-priced.

Despite the risks, though, some acquisitions turn out to be hugely profitable. So, your growth investing strategy shouldn’t automatically discount companies that have grown through acquisitions.

1. Keep stock market trends in perspective. It pays to keep in mind that the stock market often anticipates trends—but no trend lasts forever. As well, stocks sometimes put on lengthy downturns due to business and economic problems—but the downturns typically go into reverse long before the problems get resolved.

2. The best growth stocks should have the ability to profit from secular trends. These trends outlast ordinary business booms and busts, because they reflect ongoing social change. Free trade and rising environmentalism are just two examples of secular trends.

3. Pay attention to the stock’s debt. It should be manageable. When bad times hit, debt-heavy companies go broke first. This is one of the most effective ways you can mitigate risk in your own growth investing strategy.

4. This leads them to take on more risk when you invest in the top growing stocks

It’s easy to think that stock prices vary between predictable extremes of high and low. If this was so, all you’d have to do is buy low and sell high to make money. In fact, it is investor attitudes that vary widely, between greed and fear.

When greed dominates investor thinking, investors focus on profits they can make, and they downplay their fear of loss. This leads them to take on more risk. When risk backfires, costly surprises follow.

On the other hand, when fear dominates, investors focus on and exaggerate risks. This can stop them from accepting sensible risks. Many stay on the sidelines until greed takes over again, and risk is high. Then they jump into the market.

When you aim to buy low and sell high, you can wind up doing just the reverse. You may spend too much time out of the market when values are attractive. You may spend too much time in the market when risk is high. You may compound your error by focusing on risky stocks, in hopes of making up for lost time and missed profits.

Make the most aggressive or speculative of the top growing stocks just 5% of your portfolio at the most

If one of the speculative top growing stocks you’re thinking of buying seems to check out reasonably well, you may want to take a chance and add the stock to your portfolio. Ordinarily, we’d limit any one initial purchase to 5% or less.

Even if you do hold some highly aggressive growth stocks, it’s still a good idea to keep your overall portfolio well-diversified across most if not all of the five main economic sectors, That’s a key part of the Successful Investor approach. That’s especially so if the hot growth stock is in either of the two most volatile sectors, Manufacturing & Industry or Resources & Commodities.

After that, you need to monitor the stock much more closely than your other holdings, because of the speculative nature of your investment. You’ll need to make a lot of difficult sell-or-hold decisions as the stock’s fortunes wax and wane. If it rises faster than your other holdings, you’ll need to decide if you’ll sell some of your shares from time to time or if you’ll let it represent an ever-growing portion of your portfolio.

As an aside, we have a couple of portfolio management clients who have half or more of their portfolios invested in a particular stock. In many cases, the stock is one of Canada’s top five banks and was left to the client by a parent who may have inherited it. Selling the stock is out of the question. After all, “it’s been in the family for generations.” In fact, the client may leave instructions to sell the other stocks in the portfolio to pay any capital gains taxes owed on his or her death.

Plunging into a single stock can pay off nicely for several generations if you pick stocks that have performed as well as Canada’s top five banks have over the years (and that, like the banks, fit the Successful Investor approach). Unfortunately, stocks that have done as well as the banks, and for as long as the banks, are extraordinarily rare—and that’s especially true of many  growth stocks.

What tools do you use to maneuver in the growth stock arena and avoid picking stocks that fail?

What is your approach to growth stocks? Do you think they are worth the risk?


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