Is investing in growth stocks, and particularly those with large market capitalization, back in vogue? If the performance of the Russell 1000 Growth Index (RLG) vs. the Russell 1000 Value Index (RLV), and even compared to the S&P 500 (SPX), offers any indication, the answer might be yes.
Over the last year, the large-cap growth-centric RLG has handily outpaced both, up better than 17% against the SPX’s nearly 13% advance and the RLV’s almost 8%. (See figure 1.)
“The traditional definition of growth stocks were those with crazy price-to-earnings ratios that offered newer products and maybe lower market capitalization rates,” says JJ Kinahan, chief market strategist for TD Ameritrade. “But technology over the last few years has changed that view.”
Elephant in the Room: Large and Disruptive
Typically, a growth stock is a young company that is rapidly expanding in a developing industry. But, as Kinahan notes, the fast pace of technology advances has put that definition on its head. Technology is reinventing timeworn products and services like cars, house hunting and grocery shopping. And some of the companies that are pushing those products and services forward are not necessarily young with low market caps.
“You have to define what you mean by ‘growth,’” Kinahan says. “Is it the more traditional measures of growth, or is it large caps that have disruptive business models and thus the opportunity for significant growth?”
Three sectors that have been growing are technology, biotech and energy, Kinahan says. Hardly new sectors, but highly disruptive.
Growth Stocks and Market Mantras
Buying stocks when prices are low and selling them when prices are high is one of the oldest mantras in the market. But growth stocks don’t always allow that approach—many growth stocks become pricey long before a company becomes profitable. In such stocks, it’s the expectation of rapid future growth that drives stock price. In other words, growth investing generally means buying high, with all the risks involved, and hoping to sell higher.
High growth is typically necessary to justify the high price-to-earnings ratios. But remember that some growth companies might turn into “story stocks,” with interesting, and even accurate visions of the future, but lack the ability to turn ideas into profit quickly enough to satisfy shareholders. Electric cars, for example, went through numerous iterations over many decades before the right combination of technology and economics helped such vehicles come to market and be competitive, and it's still up for debate as to whether that has happened.
It might take an iron will to invest in growth stocks. They offer a potential for higher reward, certainly, but typically come with an extra amount of risk. A growth-oriented investment might someday be the next best thing to the invention of the Internet, or it might not. As you consider investing in growth, it might help to consider two other market mantras:
- Don’t put all your eggs in one basket.
- Keep some dry powder around.
In other words, growth investing can be a part of an investment portfolio, but not necessarily the entirety of its contents. And you never know when that next opportunity might come along, so be prepared.
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