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Topic: Growth Stocks

Growth investing balances an investor’s portfolio

growth-investing

Growth investing fills in the gaps in an investor’s portfolio and can lead to an increase in portfolio returns.

Growth stocks are companies that are likely to have earnings growth above the market average. Frequently, growth stocks pay little or no dividends. Instead they typically re-invest any extra cash flow to promote further growth.

Hold a mix of growth and value stocks

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


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In any event, it’s impossible to come up with a one-size-fits-all answer when talking about the best balance among value stocks, more aggressive small stocks and growth stocks (some of which can fall into more than one category). The right answer for you depends on your investment objectives and financial circumstances. It also depends on the market outlook, and on where the best deals are available.

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 a 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 you least expect.

By combining growth and value in a portfolio, you can achieve good results while holding down volatility.

Most important, 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.

Growth investing is not momentum investing

Don’t confuse growth stocks with momentum stocks:Momentum managers focus on growth stocks; but they want to hold only while prices are rising. They don’t mind paying a high price, because they plan to sell as soon as the rise begins to falter.

Momentum stocks are stocks with prices that are moving higher quickly in a market usually ahead of earnings growth. Momentum investors are particularly 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 computerized 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.

Momentum investing theory can be summed up as “buy high, sell higher”. The trouble is that when the stock’s rise falters, momentum investors also try to get out as a group, but there are never enough buyers. This leads to violent price fluctuations—and often big losses.

All in all, while true growth stocks can be more volatile than value stocks, they often make good long-term investments. They may be well-known stars or quiet gems, but they do share one common attribute—they are growing at a higher-than-average rate within their industry, or within the market as a whole, for years or decades.

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