How to Think About Growth Stocks

Growth stocks have taken a beating lately.

We all know by now about Netflix's (Nasdaq: NFLX  ) spectacular fall from grace, for example. Another highflier, Green Mountain Coffee Roasters (Nasdaq: GMCR  ) , was laid low recently by the highly esteemed David Einhorn, who gave a very unflattering presentation on the company at the Value Investing Congress. And just the other day, Amazon.com's (Nasdaq: AMZN  ) share price was taken to the woodshed after it missed on earnings.

Should investors stay away from growth stocks in the current environment?

No, says Dave Meier, advisor of Million Dollar Portfolio. I asked Dave this precise question recently, and learned that he never thinks of growth stocks as an entire category. Rather, he feels that the context around any particular company is everything. And when looking at a specific company, he likes to ask himself the following three questions:

  1. Where is the company in its life cycle right now?
  2. How did it get to where it is today?
  3. Where is the company headed?

To illustrate how these questions work, Dave talked about one of his favorite investment ideas right now: Zipcar (Nasdaq: ZIP  ) .

Where is Zipcar right now?
Currently, Zipcar is the leading car share company in the world, with approximately 9,500 cars and 600,000 members. It has first-mover advantage over competitors like Hertz's (NYSE: HTZ  ) car-sharing Connect Service, and has a loyal band of followers who call themselves Zipsters. Dave notes that the 10 million drivers live within a 10-minute walk of a Zipcar vehicle. Even though the company isn't delivering net profits quite yet, its future possibilities are tremendous.

How did Zipcar get to where it is today?
Zipcar earned its place in the market by offering an attractive alternative to owning a car in an urban area. We all know that cars are expensive and a hassle (try finding a parking space for an Oldsmobile in downtown Boston). Zipcar totally got it and was inspired to bring the European car-sharing culture to the U.S. And its customers have embraced this culture with open arms.

Dave feels that the genius of the business is that, as a result of its membership model and on-demand services, it's one part Costco and one part Netflix. So far, that model has allowed the company to fire on all cylinders.

Where is it headed?
When asked where the company is headed, Dave responded succinctly, "Everywhere it can."

Dave believes that Zipcar is following the model of burning cash early on to invest in its car-sharing network, which Chipotle (Nasdaq: CMG  ) used to become successful with its fast-casual restaurants. That wise investment strategy combined with an outstanding market opportunity could result in significant outperformance over the long term.

Four questions minus one
It seems clear to me that the question of whether growth stocks are overvalued right now is the wrong question to ask. Instead, investors may find it easier and more profitable to ask the three questions of individual companies that Dave has provided. The thing I like best about Dave's approach is that it appears to follow Einstein's sage advice of making things, "as simple as possible, but not simpler."

For an additional growth stock idea, have a look at our latest free report. The company highlighted, like Zipcar, is a recent IPO with incredible promise. The report is entirely free. Click here to get yours right now.

John Reeves owns shares of Chipotle and Costco.

The Motley Fool owns shares of Zipcar, Hertz, Chipotle, and Costco. Motley Fool newsletter services have recommended buying shares of Costco, Zipcar, Green Mountain, Netflix, Amazon.com, and Chipotle; as well as creating a put butterfly position in Chipotle and a lurking gator position in Green Mountain. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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