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Investing in Growth Stocks - Some Pointers

May 22nd, 2020

Investing in stocks that are a rage is a never ending lure for self-directed individual retail investors. In weekend parties when we hear a friend brag about making a killing in Apple stock, our ETF/Mutual Fund investor friends can be wondering why they missed that boat. The next day they do their quick research and when the market opens the following Monday they quickly go to place that heart warming order to buy AAPL.

AAPL is a clear growth stock and undoubtedly many people have profitable investment experiences buying that stock. What worked for those people is something individual self-directed investors will need to consider.

Growth Stock investing is one of the most exciting and challenging pursuits for self-directed investors and utmost caution is required if they want be consistently profitable investing in them.

Here are some of the most important pointers self-directed individual investors must not overlook while trying to make money in growth stocks.

High Demand for Company's Product or Service

A typical growth company provides products or services that are needed in the present and these products and/or services are also in high demand. These companies' stocks will be clearly outperforming the broader market. Companies like Service Now, Trade Desk, Tesla, Shopify and many more fall in this category. Even some established companies like Apple, NetFlix, Microsoft continue to be classified in this category as there is a high demand for their products/services.

Revenue Growth More Important Than Earnings

Revenue is an important denominator for companies which are in their early stages of growth. Investors expect early stage growth stocks to show a healthy revenue growth quarter-over-quarter and year-over-year. This revenue growth often is not accompanied by a growth in earnings and investors tend to overlook that as these early-stage companies typically spend more on R&D, Advertising and other market-share gaining activities which cut into earnings heavily.

Earnings Misses Are Punished Severely

A clutch of growth stocks moves on to the next stage of their growth cycle once they start showing bottom line growth as well along with solid top line gains. These companies typically demonstrate healthy earnings growth quarter-over-quarter and investors clearly attach a higher premium to this growth and their stock prices starts flying high. But it is a reality of life these companies cannot demonstrate exponential earnings growth every quarter and at some point the music stops for a bit when a high flying growth company will miss a quarterly earnings expectation number. Institutional investors become wary about future growth and they turn a bit cautious by unloading probably a sizeable portion of their positions. Hence, it is not unusual for a high flying growth stock to lose at least 20% to 30% of its value in a matter of days before it heads to a period of consolidation on an earnings miss. In our view, this is the single most important risk growth stock investors will need to be able to manage to be successful.

Supportive Market

Growth Stocks tend to do well when that part of the economy they are feeding to shows growth. When the overall economy shows a recessionary tendency or slow down, these growth stocks are severly impacted and their stock prices tend fall a lot more than established large cap mature companies. Conversely, it is also true, when the broader market is reacting to an expanding economy growth stocks tend to do a lot better. This is an important factor self-directed individual retail investors will need to keep in mind while investing in growth stocks. If the broader market is consolidating it will be extremely difficult for growth stock investors to be profitable.

High Volatility

Earnings Volatility, Emergence of Competitors, New Share Issuance are some of the most noteworthy events which tend to make the prices of growth stocks extremely volatile. Up and Down single day price moves of 3% to 5% are not uncommon. This kind of volatility can unnerve investors and shake out many retail investors. Self-directed investors who are diving into growth stock investing have to be prepared for high volatility and sharp paper profits/losses in this journey. A proper, disciplined and nimble approach is imperative for success.

Entry and Exit Criteria Crucial

For growth stock investors to succeed, after considering the aforementioned factors, it all boils down to having proper entry/exit points. It will matter when to buy quality growth stocks and when to sell when the tide turns sharply against their positions. Self-directed individual investors with a disciplined approach will succceed if they can cut their losses short and take profits as they come without being too greedy.

Good Luck and Safe Investing!