Riddle me this, savvy investor: When is good news actually bad news?
By way of an answer, consider Qualcomm (Nasdaq: QCOM), Altera (Nasdaq: ALTR), and Las Vegas Sands (NYSE: LVS). Each of these companies has a higher forward price-to-earnings ratio (P/E) than the S&P 500's. However, over the past 12 months, they've also lagged the S&P in stock price performance. The same is true of Adobe Systems (Nasdaq: ADBE), Automatic Data Processing (NYSE: ADP), and Western Union (NYSE: WU), too.
So what, exactly, is the problem? Call it the rosy scenario syndrome: Analysts expect double-digit earnings growth for each of those stocks over the next five years.
Isn't that good news?
In the abstract -- and if the analysts turn out to be right -- that's good news indeed. But the market is especially efficient when it comes to pricing in (or discounting for) growth stories. So, when macroeconomic data or industry-specific news comes along and shakes up the rosy growth story, highfliers like these will drop in a hurry.
I'm not saying you shouldn't own them. Companies with high growth prospects are nothing to sneeze at, particularly if you've got a stomach for volatility. But even if you consider yourself an investing genius, a smart way to snag the market's pricier prospects is through world-class mutual funds. You'll get the market-beating potential of growth stocks, along with a smartly constructed portfolio that should help tame wild performance swings.
Two for the price of one
But not just any fund will do. As part of the Fool's fund research team, I'm constantly on the lookout for:
1. Strategic tenacity: With growth investing pretty much in the doldrums since the market melted down in early 2000, we're especially interested in growth funds led by managers who have stuck to their guns during this downturn, snapping up the companies they like at substantial discounts to their earnings-growth potential. After all, investing in otherwise rock-solid companies when their area of the market has fallen from favor means managers are buying quality at discounted prices.
2. Healthy skepticism: Managers who fall in love with a stock's "story" don't make the cut. When it comes to growth investing in particular, it's too easy to become overly wowed and fall prey to "irrational exuberance." (See the late 1990s for the gory details.) With that in mind, we want growth managers to be as unemotional about their work as possible -- and to have defined sell criteria. Yes, we should all be inclined to let our winners run. We shouldn't, however, let them run away.
3. Intelligently placed bets: Risk is baked into growth investing, and because we want to beat the market and get a good night's rest, we favor managers who run intelligently diversified portfolios. We're not averse to funds that pack considerable sums into individual names or certain areas of the market. But at the same time, you likely won't find us recommending, say, a tech-sector fund, either. There are smarter ways of getting the growth job done.
Speaking of which ...
If you'd like to invest fearlessly in the market's "scariest" stocks, consider taking the Fool's Champion Funds service for a risk-free spin. Our overall list of recommendations is spanking the market as I type. And yes, we do have a selection of terrific growth funds -- hand-picked go-getters that have what it takes to get the market-beating job done.
Click here to give Champion Funds a test drive, and find out more about why top-notch mutual funds make the ideal safeguard for your money.
This is adapted from a Shannon Zimmerman article originally published Jan. 16, 2007. It has been updated.
Fool analyst Adam J. Wiederman is a daredevil with brains. He owns no shares of any company mentioned above. Western Union is an Inside Value recommendation. You can check out the Fool's strict disclosure policy by clicking right here.
Terms & Conditions
RSS Headlines
Fool UK