Growth investing is like playing cards with Dr. Jekyll while avoiding Mr. Hyde. The returns on investing in the next big thing are the stuff of legends but the stock market can turn against you in an instant. Investing in the stocks of high-growth companies does not have to be prohibitively risky if you maintain a rational perspective and a skeptical eye.
Investing in the next big thing
Growth investing is the sexy side of Wall Street. It’s a way for an everyday guy like you and me to make it big and reach all of our financial dreams decades earlier than expected.
If you are old enough to remember the great tech boom of the ‘90s then you know what I mean. Investors buying shares of the Oracle Corporation (ORCL) saw their investments surge 21-fold in the five years to August 2000.
Growth investing didn’t die out with the popping of the tech bubble. Shares of Tesla Motors (TSLA) jumped 450% in the first 10 months of 2013.
The idea is that the market heavyweights of tomorrow all start out as smaller companies with just the hope of sales. If their product or service becomes mainstream, revenue growth can surge for years. Revenues at Oracle increased from just $1 billion in 1991 to close out the decade at $10 billion. Early investors not only benefit from the increase in sales and company fundamentals but also as other investors buy into the growth story.
All the clichés about things too good to be true and what goes up also apply to growth investing. The internet bubble popped spectacularly in 2000 and shares of Tesla Motors fell more than 30% soon after reaching almost $200 per share.
Growth at a Reasonable Price
There may not be a ‘trick’ to growth investing that avoids the crashes but investors can still make some breathtaking returns if they stay grounded and do a little extra homework.
Measures of value like the price-to-earnings ratio may not be as relevant with growth stocks. Earnings are extremely low or nonexistent and the market is pricing these companies almost entirely on future growth. Even after more than a decade, Amazon (AMZN) still has yet to post regular earnings growth but has seen its share price jump seven-fold in the five years to 2014.
This is why you really need to do some homework for growth investing. If the future price depends on stellar growth in sales, then you need to track those sales. Who are the company’s main suppliers? Who are its primary buyers? If there are local sellers of the product, talk to the person responsible for buying from the company. You might be able to get some insight into how quickly the product is selling. Talking with someone that works with a primary supplier might give you an idea that the company has increased or decreased its purchases of materials.
You do not have to be able to predict the exact level of sales or growth, you just need to know if the growth trend is increasing or decreasing. I like to make connections with at least one expert in the industry in which the company operates. After watching shares of Apple (AAPL) do nothing for decades, I bought the stock in 2002 after talking with a tech friend of mine that could not stop talking about how the new iPod products were going to change retail electronics.
Even if you are confident that growth will continue for a company, it still pays to stay grounded and take your profits every once in a while. I figure that for every five growth companies, one will completely fail and one will beat my expectations while the other three will fall somewhere in the middle. If I double my investment on one or two stocks then I can still average out to really nice returns as long as the rest do not completely flop.