Growth investing isn't easy. It's been said by financial gurus that the premise for evaluating stocks for growth is basically that stock prices will follow earnings and that when earnings rise, so do the stock prices. Doesn't always work, though.
In order to figure out which companies will have earnings increases, you have to do a little estimating, which as we all know, is not all that reliable. I would simply call it a Guesstimate.
Of course, we've seen some rather dramatic gains here. For example, in 1998 and 1999, large-company growth funds earned an average of 33 percent and 39 percent, respectively. Not shabby at all unless, of course, you count in the wonderful years of 2000-2002 when they dropped like a stone to the tune of 58 percent.
Why did this happen? A loss of 58 percent compared with gains of 33 percent and 39 percent? Keep in mind that growth stocks are quite expensive compared with their past 12 months' earnings. For instance, a company that earned $1 a share last year and now sells for $35, has a price-earnings ratio of 35. That's high. But suppose you guesstimate that the earnings will double? Therefore, P-E shrinks to 17.5.
Naturally, you better be right; otherwise, you'll go into the dumpster. For instance, Cisco dropped from $80.06 to $8.60.
So, why bother with growth stocks? Because if you believe that our economic expansion will continue, then growth funds will boost your portfolio.
By the way, growth funds generally run after three areas: Healthcare because nearly 78 million people born from 1946 to 1964 are coming into the spotlight and that usually means a benefit for drug manufacturers. Think biotechnology.
Secondly, technology itself is starting to ride the comeback trail and finally, in the finance area where financial services entities usually benefit from any bull market. As one expert tells me, when the market goes up 20 percent, revenue goes up a similar amount, with no attendant costs.
However, like anything else, it is prudent to be realistic. Remember what just happened. Make sure that you have some basic income and capital preservation sitting in that portfolio to hedge the bet.
