Investment Strategies (part C)
by
Charles Lamson
Growth Strategy
If you remember our discussions on growth mutual funds and growth stocks, we defined growth as seeking investments that will increase in value (share price and/or dividends), but primarily focused on companies with tremendous growth potential.
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Growth stocks are typically characterized by a history of growth in all or many areas of financial measurement including profits, sales, and so on. Growth stocks usually do not pay dividends, although this is not an absolute. Growth mutual funds invest in growth stocks.
Growth strategies, whether by mutual funds or individual investors, look for those companies that are about to move up to the next level in market prominence. This growth potential is worth a lot to investors if you consider number of Internet and technology stocks that are selling at a huge premium profit to earnings or no P/E at all because they have yet to make a profit.
It might be helpful if we are more specific in defining growth and then examine how and when a growth strategy is appropriate.
Defining Growth
It may have occurred to you by now that our definition of growth lacks any way to quantify how much or what kind of growth. Without some measurable key, growth is a very subjective measurement.
Is a growth stock one that appreciates at X percent per year? Is it a company that shows a Y percent increase in profits? Moreover, how do you measure potential?
Rather than picking an arbitrary growth figure out of the air, what if we measured growth against a benchmark? Which benchmark would be best?
Defining growth turns out to be a little more complicated than it looks. This is where I put in another plug for doing your research online; whether you buy a computer or use one at the library, you can perform some very sophisticated screens using Internet tools.
These resources, called screens, are available from a number of Web sites. The great thing about using screens is that you can look at thousands of stocks and mutual funds in seconds.
An even greater benefit is that most of the screening Web sites have predefined screens already set, so all you have to do is run them. For example, www.morningstar.com has a number of predefined screens in its free section and even more powerful screens in the premium area.
The experts at Morningstar.com have put together some logical screens based on a number of criteria. For example, their growth screen compares stock growth to the S&P 500 and industry peers in order to pick out the best.
There is no way you could accomplish this amount of work in weeks if you did it manually. This is another of the many reasons you will have much better success as an active investor if you learn to use the Internet and the many services it offers.
In a later post, we will go over the important numbers you need to look at in making an investment decision. Most of these important numbers are already calculated for you by the online services. There are several more conventional services that offer detailed analysis of stocks and many of their offerings can be found at your library.
So, we have decided that growth is something we can quantify and define. This gives us a tool to pick out stocks and mutual funds. Now, we need to decide how to use those stocks and mutual funds in a strategy that is appropriate for our particular goals.
Using a Growth Strategy
A growth strategy is an aggressive approach to investing. Most growth candidates are going to be younger companies just beginning to reach their stride. You are counting on the stocks and mutual funds to grow over time. The operative word here is "time." A growth strategy is not an appropriate tool to achieve a short-term goal.
A growth strategy assumes that there will be time to allow the investment to mature. Companies that are in strong growth modes tend to be more volatile (meaning wider price fluctuations) than more stable or mature companies. This means that over the course of your investment there will be times when the stock is up and times when it is down.
The market is not kind to growth stocks that stumble. Short-term investors will jump in and out of stocks on minor changes in price. This is not a long-term strategy. The long-term investor expects some ups and downs. However, you certainly do not want to be wedded to a stock that you ride it into the ground. Things change and if you are going to be an investor, you need to know when to hold 'em and when to fold 'em.
A growth strategy is probably most often used to fund or supplement a retirement program. Given the long-term nature of this goal, we can make some observations based on the age of the investor.
Most financial advisers recommend very aggressive investing for the very young; after all, they have 45 years in front of them to correct any mistakes. More importantly, an aggressive growth strategy at this age has an excellent chance of assuring a retirement with a seven-figure nest egg.
An aggressive growth strategy is likely to produce some capital gains, especially if invested in mutual funds, that should be sheltered in a tax-deferred retirement account. This of course allows the account to grow without paying any tax on current earnings.
What to Invest in for Growth
We have determined that growth investing is most appropriate for long-term goals, but what type of investment instruments make sense for this strategy? Many financial advisers suggest you consider something like a small-cap growth mutual funds if you are more comfortable with that kind of investing.
For the active investor, technology stocks have been where some dramatic growth has occurred in the past several decades, with no firm end in sight. A stock screen service may pick out some other possibilities, such as companies poised for a potential turnaround, companies that are underpriced, and stocks moving with momentum (Momentum in this case means stocks that have a strong wind behind them in terms of recent stock price increases.)
*SOURCE: ALPHA TEACH YOURSELF INVESTING IN 24 HOURS, 2000, KEN LITTLE, PGS. 223-227*
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