A growth stock may be defined as one which has done this in the past and is expected to do so in the future.
[A company with an ordinary record cannot be called a growth company or a "growth stock" merely because its proponent expects it to do better than the average in the future. It is just a "promising company."]
It seems only logical that the intelligent investor should concentrate upon the selection of growth stocks.
It is mere statistical chore to identify companies that have "outperformed the averages" in the past.
However, investing successfully in them is more complicated.
Two Catches of Growth Stock Investing
Two catches to watch out for in growth investing.
1. The common stocks with good records and apparently good prospects sell at correspondingly high prices.
- The investor may be right in his judgement of their prospects and still not fare particularly well, merely because he has paid in full (and perhaps overpaid) for the expected prosperity.
2. His judgement as to the future may prove wrong.
- Unusually rapid growth cannot keep up forever; when a company has already registered a brilliant expansion, its very increase in size makes a repetition of its achievement very difficult.
- At some point the growth curve flattens out, and in many cases it turns downward.
Naturally, the purchase at a time when popular growth stocks were most favoured and active in the market would have had disastrous consequences.
- They were too obvious a choice.
- Their future was already being paid for in the price.
- Popular growth stocks may have failed to continue their progress and have even reported downright disappointing results.
How can your investment into growth stocks be protected?
Presumably, it is the function of intelligent investment to overcome these hazards by the exercise of sound judgement and skillful selection.
This is the natural and appropriate endeavour for the enterprising investor.
Benjamin Graham regrets that he has little concrete guidance to offer the enterprising investor in this field.
The exercise of specialized foresight, the weighing of future probabilities and possibilities are not to be learned out of books - nor can they be aided much by suggested rules and techniques.
Elaborate study of the life cycle of industries and discussing a number of "symptoms of decay"; by noticing of which the alert investor may escape out of a once expanding industry before it is too late.
These suggested techniques require more ability and application than most investors can bring to bear on the problem.
[It is debatable whether once an industry has turned downward, it will never recover and that all securities within it must be permanently avoided.]
More guidance on Growth Stock Investing
The stock of a growing company, if purchasable at a suitable price, is obviously preferable to others.
No matter how enthusiastic the investor may feel about the prospects of a particular company, however, he should set a limit upon the price that he is willing to pay for such prospects.
- Such a rule would result at times in the missing of an unusually good opportunity.
- More often, it would mean the investor's saving himself from "going overboard" on an issue that looked especially good to him and everyone else and consequently was selling much too high.
An illustration of investing in growth stocks
Two highly successful enterprises and both were considered to have excellent prospects of long-term growth. Both were priced at 22 times that year's earnings. The average price of Company A in 1939 was 62 and the price of company B in 1939 was 42. The ordinary investor was as likely to buy one issue as the other.
Company A Company B Company C
1939 1947 1939 1947 1939 1947
Price 62 150 42 29 6 26
Earnings 2.9 10.9 1.89 2.13 0.13 3.14
P/E 22 22
The choice between the attractive issue that turns out well and the one that does poorly is by no means easy to make in the growth-stock field.
At the same time, it might be interesting to add a third pharmaceutical Company C which was by no means well regarded in 1939 - for its average price was only 6 (as against 28 in 1929) and it paid no dividend. On its past record it could not qualify at all as a growth issue. Yet in 1947 its earnings were $3.14 per share as against only 13 cents in 1939, and its April price in 1948 had risen to 26 - a much better percentage gain than CompanyA's.
The best opportunity in the field of drug stocks turned out to be where it was least expected - an all too frequent happening.
Inferences from the above illustration for investing in Growth Stocks
- Superior results may be obtained in this field if the choices are competently made.
- Even with careful selection, some of the individual issues may fare relatively poorly. Some may actually decline and others may have only slight advances
- Thus for good results in the growth stock field there is need not only for skillful analysis but for ample diversification as well.
Summary on investing in Growth Stocks
- The enterprising investor may properly buy growth stocks.
- He should beware of paying excessively for them. He might well limit the price by some practical rule.
- A growth stock program will not be automatically successful; its outcome will depend on the foresight and judgement of the investor or his advisors rather than on any clear-cut methods of analysis.