Track the companies that matter to you. It's FREE! Click one of these fan favorites to get started: Apple; Google; Ford.



Don't Fall Into the Growth Trap

Over the past year, you've heard plenty of warnings about value traps -- the allure of mature businesses that suddenly look cheap after a big market drop. As unfortunate investors in stocks like General Electric (NYSE: GE  ) can attest, just because share prices have fallen a bunch doesn't mean they can't keep falling further.

What hasn't gotten as much investor attention thus far, however, is a different trap that primarily affects growth stocks. As the economy slows, many high-growth companies have to face up to falling earnings and revenue growth rates as well. Yet if you put too much faith in analyst estimates of future financial results, you could find yourself making a bad bet on a stock that proves not to be the great growth candidate you thought it was.

Adjusting expectations
With value stocks, the first thing many investors look for is the price-to-earnings ratio. Low P/Es are many value investors' dream, although you have to be careful to avoid the many pitfalls of relying on that measure. Anything from one-time windfall profits that are unlikely ever to be repeated to unusual accounting practices can make reported earnings an unreliable figure on which to base valuation.

For growth stocks, on the other hand, most investors focus on strong future earnings growth. As long as a company can sustain strong growth, it can retain a following of loyal investors and the high valuations that often come with that growth.

But with the economy in recession, growth estimates have started to collapse on many stocks. Below is a sample of how analysts have revised their estimates on next year's earnings for a few growth stocks:


Forward EPS Estimate as of 90 days ago

Forward EPS Estimate as of today

Change (Nasdaq: AMZN  )




Autodesk (Nasdaq: ADSK  )




Google (Nasdaq: GOOG  )




Juniper Networks (Nasdaq: JNPR  )




International Paper (NYSE: IP  )




Iron Mountain (NYSE: IRM  )




Source: Yahoo! Finance.

As you'd expect, some companies have been particularly hard-hit, while others have only suffered glancing blows thus far. But in the next table, notice how little pessimism analysts have further into the future:


Growth Estimate for Next Year

Growth Estimate Over Next 5 Years









Juniper Networks



International Paper



Iron Mountain



Source: Yahoo! Finance.

Except arguably for Google, each of these companies will face a monumental task in meeting its five-year growth benchmarks after what is projected to be a subpar 2009. For International Paper to reach its 5% five-year projection if it loses more than half its earnings next year, it would have to grow earnings more than 165% from 2010 to 2014. Amazon will have to have 143% earnings growth over the same four years to reach its target. While not inconceivable, those projections rely on an optimistic assessment of the economy's current troubles.

Stay reasonable
The problem with those rosy numbers is that for growth stocks, future estimates form the foundation of a huge part of stock valuation analysis. So if you use numbers that turn out to be highly inaccurate, what seems like a smart investment decision now may prove to be disastrous a year or two down the road.

To stay out of the growth trap, form your own independent assessment of future growth, especially beyond the next two or three years. Analysts are far from perfect at assessing a company's prospects even one year in advance, let alone five -- so don't let an amazing-looking growth rate trick you into buying a dud stock.

For more on investing in growth stocks, read about:

Need help evaluating growth stocks with huge potential? Our Motley Fool Rule Breakers newsletter looks for the top movers in promising new industries that have the potential to become tomorrow's leaders. Try it out now free for 30 days.

Fool contributor Dan Caplinger has always been skeptical of analyst projections. He owns shares of GE. International Paper is a Motley Fool Income Investor selection, Google is a Rule Breakers pick, and is a Stock Advisor recommendation. Try any of our Foolish newsletters today, free for 30 days. The Fool's disclosure policy tells it like it is.

Read/Post Comments (0) | Recommend This Article (6)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

Be the first one to comment on this article.

Compare Brokers

Fool Disclosure

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 817089, ~/Articles/ArticleHandler.aspx, 10/23/2016 12:28:18 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...

Today's Market

updated 1 day ago Sponsored by:
DOW 18,145.71 -16.64 -0.09%
S&P 500 2,141.16 -0.18 -0.01%
NASD 5,257.40 15.57 0.30%

Create My Watchlist

Go to My Watchlist

You don't seem to be following any stocks yet!

Better investing starts with a watchlist. Now you can create a personalized watchlist and get immediate access to the personalized information you need to make successful investing decisions.

Data delayed up to 5 minutes

Related Tickers

10/21/2016 4:00 PM
ADSK $71.18 Up +0.05 +0.07%
Autodesk CAPS Rating: ***
AMZN $818.99 Up +8.67 +1.07% CAPS Rating: ****
GE $28.98 Down -0.09 -0.31%
General Electric CAPS Rating: ****
GOOGL $824.06 Up +2.43 +0.30%
Alphabet (A shares… CAPS Rating: *****
IP $47.00 Down -0.18 -0.38%
International Pape… CAPS Rating: ****
IRM $33.97 Down -0.08 -0.23%
Iron Mountain CAPS Rating: ***
JNPR $23.13 Up +0.38 +1.67%
Juniper Networks CAPS Rating: **