The Danger of Buying Growth Stocks

NYSE: SPY | SPDR S&P 500 News, Ratings, and Charts

SPY – The stocks that excite us the most actually have the most downside potential. Here is a better way to find healthy growth stocks ready to rise.

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When you ask most investors for their favorite stocks, you’ll rarely hear them share a blue chip name like Citigroup or Wal-Mart. Instead they will tell you about some amazing growth stock that will be the next Google or Amazon.

These investors believe that by simply buying stocks with the greatest earnings growth potential that they will make money. Sadly the academic research clearly shows this not be true…not even close.

In this article I will dispel the myth about investing in growth stocks just for growth’s sake. Instead I am going to shine the light on a path that has more consistently paved the way to profits.

Why Don’t Most Growth Stocks Pan Out?

The early investors in growth stocks usually do quite well. They take the early risk when almost no one has heard of the company. As the company bangs out earnings surprise after earnings surprise, it gains more investor attention and a much higher share price.

However, at some point the company will be “priced for perfection“. Meaning that the PE gets too inflated as people are so sure that the good times will just keep rolling (think of a mini-version of the late 90s tech bubble).

Unfortunately, the exceptional growth rarely holds up over time. At some point, as the company tries to expand so rapidly, it will stumble. Even if that just means going from a robust 30% annual growth rate to 20%. On the surface 20% growth is still impressive . . . but not to the investors who expected 30%. So naturally the stock will tank…and tank fast.

I’m sure you’ve had a few of these stocks in your portfolio over the years. So I don’t have to remind you how quickly the losses add up. That, in a nutshell, is the danger of investing in growth stocks.

So What Does Work?

The key is to find stocks that exceed expectations no matter the growth rate. Meaning that a stock that is expected to grow profits by 5% and ends up growing by 7% will do very well. Ditto for a stock expected to grow 30% that ends up at 35% actual earnings growth.

I know on the surface it sounds like you need a crystal ball to predict which companies will beat their earnings projections. Gladly, it’s actually much easier than you think. It really boils down to this:

Companies that produced beat and raise earnings reports in the recent past are more likely to repeat that feat  in the future.

And those that miss expectations are much more likely to repeat that failure.

Another term for this is earnings momentum. That is a quality you want packed inside your stocks increasing the odds of future outperformance. In fact, almost all the stock recommendation articles I write for StockNews.com includes this vital criteria.

Below is a collection of some of the most recent articles I have written. Each highlights stocks packed to the brim with positive earnings momentum and other criteria that increases the odds of future outperformance. Enjoy!

3 Strong Buy Upgrades You Need to Know About

12 Stocks with 50%+ Upside

10 Perfect Stocks for November

Reitmeister Total Return portfolio – currently has 10 stocks with ample earnings momentum.

Wishing you a world of investment success!


Steve Reitmeister

…but my friends call me Reity (pronounced “Righty”)
CEO, Stock News Network

Editor, Reitmeister Total Return

 


SPY shares were trading at $310.00 per share on Friday morning, down $0.27 (-0.09%). Year-to-date, SPY has gained 25.77%, versus a 25.77% rise in the benchmark S&P 500 index during the same period.

 


About the Author: Steve Reitmeister


Steve is better known to the StockNews audience as “Reity”. Not only is he the CEO of the firm, but he also shares his 40 years of investment experience in the Reitmeister Total Return portfolio. Learn more about Reity’s background, along with links to his most recent articles and stock picks. More...


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