3 Steps to AVOID Dangerous Growth Stocks
Finding the right growth stocks to add to your portfolio is no easy task. But if you know how to find these hidden gems, they can become some of the...
Finding the right growth stocks to add to your portfolio is no easy task. But if you know how to find these hidden gems, they can become some of the most profitable stocks you will ever own. In today's commentary, I'll discuss what makes growth stocks so exciting and appealing, and how to avoid the all too common pitfalls of investing in these types of companies. Read on below to find out more.
Over the last 2 years, we've learned exactly why growth stocks are so exciting and appealing and exactly why a lot of people are probably better off not even trying.
From March 2020 to the early parts of 2021, we watched growth stocks or funds like Peleton, Zoom, and ARK Innovation ETF climb many multiples…only for the majority of these gains to evaporate over the last few months.
Over the last year, PTON is down by 83%, ZM is down by 63%, and ARKK is down by 51%.
In fact, if you look at the retail fund flows data, it's fair to conclude that most retail investors lost money as inflows were at their highest level during the final weeks of their ascent. These investors made the rookie mistake of buying high and selling low and learned a very expensive lesson.
We're naturally drawn to growth stocks, because the best-performing stocks of the future will emerge from this group. These are the companies that are transforming industries or even spawning new ones in many instances and have the potential to deliver life-changing returns.
The problem is that the vast majority of growth stocks are egregiously overpriced and have no chance to deliver enough future profits to justify their far too lofty valuations.
This is why I wanted to talk about 3 clear cut solutions that will increase your odds of success when selecting growth stocks.
#1 Eliminate the Worst
If you want to get healthy and live longer, you might think about signing up for a marathon, joining a gym, or trying the newest fad diet.
BUT, these extreme efforts wouldn't be worth it if you weren't doing the simple things like wearing a seatbelt, paying attention to the road while driving, or quitting cigarettes.
The same thing is true for investors. The easiest and simplest way to enhance your success with growth investing is by eliminating the most speculative and frothiest stocks from your portfolio.
One way to do this is by having an objective, quantitative-based system that evaluates stocks… with ZERO emotion. Like our POWR Ratings system based on 118 different factors that help predict the stocks future potential.
This system has consistently ranked stocks like PTON and ZM as being Fs (Sells) or Ds (Strong Sells) over the past year and can effectively weed out such "portfolio destroyers".
On the other hand, A and B-rated stocks have consistently outperformed the market with average annual returns of +31.10% and +20.10%, respectively, handily beating the S&P 500's average annual performance under 8%.
Just like school, the more A's and B's you have in your portfolio the better.
#2 Focus on the Leaders
The second solution for growth investing is to focus on the leading stocks. This is even more the case in newer industries which are skewing to be more winner-take-all.
For instance, Apple accounts for about 90% of the profits in the smartphone market, while trillion-dollar industries like e-commerce, cloud computing, search, and social media are dominated by 1 or 2 companies.
These are the companies with an early-mover advantage, dominant market share, and the most innovative and capable management teams.
The lagging companies can seem tempting because they are often cheaper and can feel like they have more upside. Unfortunately during corrections, these tend to tumble the most. Further, while the leaders go on to make new highs, the laggards often fail to recapture their previous glory.
Therefore, growth investors should identify and focus on the leading stocks in any category.
#3 Operating Leverage
The final piece of the growth investing puzzle is to look for companies with operating leverage.
This is the secret sauce for some of the best-performing growth stocks throughout stock market history. Companies with high degrees of operating leverage are able to see large chunks of revenue growth go straight to the bottom line.
Similarly, they are able to use their dominance in one market to allow them to capture market share in adjacent markets.
Think about how Microsoft was able to use its dominance in enterprise software to provide free cloud computing credits to its customers to get Microsoft Azure off the ground which has led to more than a trillion dollars in value created for shareholders. Or how Apple is able to capture revenue from the proceeds earned by developers on its app store.
Companies with operating leverage tend to have products that quickly become essential for businesses and consumers leading to pricing power and high levels of recurring revenue.
It's the magic ingredient behind companies that do realize their potential, are able to compound earnings growth for decades, and deliver life-changing returns for investors.
What To Do Next?
Discovering these types of quality growth stocks is exactly what I do for subscribers to my POWR Growth Newsletter.
This newsletter takes a proven approach to consistently find the best growth stocks, utilizing our proprietary Top 10 Growth Stocks strategy with average annual returns of +48.22%.
And in 2021 this strategy more than proved its efficacy by producing impressive +81.14% gains.
I'll be adding 2 more stocks with explosive growth potential to the POWR Growth Portfolio this coming Monday morning, February 7th.
These fresh picks, along with the other 11 exciting companies currently in the POWR Growth portfolio, are exclusively available to POWR Growth members.
Gladly you can become a member for the next 30 days for just $1. Simply click the link below to get started.
All the Best!
Chief Growth Strategist, StockNews
Editor, POWR Growth Newsletter
SPY shares were trading at $445.71 per share on Friday morning, down $0.89 (-0.20%). Year-to-date, SPY has declined -6.16%, versus a % rise in the benchmark S&P 500 index during the same period.
About the Author: Jaimini Desai
Jaimini Desai has been a financial writer and reporter for nearly a decade. His goal is to help readers identify risks and opportunities in the markets. He is the Chief Growth Strategist for StockNews.com and the editor of the POWR Growth and POWR Stocks Under $10 newsletters. Learn more about Jaimini's background, along with links to his most recent articles.
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