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A Growth Investor's Lament

Evan Niu (TMFNewCow)
May 21, 2012

I have a confession to make. I've been having somewhat of a Foolish identity crisis of late. My predicament is indubitably linked to a crisis of confidence I've been experiencing. I'm just full of crises these days.

Sometimes I just feel like the world's worst investor.

Who am I?
I'm a relatively young investor, so my long time horizon affords me a relatively high risk tolerance. I'm also a gambler at heart, as I used to play poker constantly, adding to my risk tolerance as an investor.

I've always been attracted to small-cap growth stocks with multibagger potential, which is also why I was a Rule Breakers subscriber before becoming a full-time Fool. Fortunately, the sector that I'm most interested in -- technology -- is chock-full of Rule Breakers in the making. Unfortunately, sometimes they get punished.

Lesson learned
One of the most important lessons that I've learned from Fool co-founder David Gardner is that lofty P/E ratios alone don't paint the whole picture. True Rule Breakers that have disruptive, multibagger potential deserve that premium valuation.

For example, two of the best-performing Rule Breakers picks, Baidu (Nasdaq: BIDU  ) and Chipotle Mexican Grill (NYSE: CMG  ) , have long sported lofty multiples. Baidu's P/E is no stranger to triple-digit territory.

BIDU P/E Ratio Chart

BIDU P/E Ratio data by YCharts

If high multiples alone had kept you away, then you missed out on this performance.

BIDU Chart

BIDU data by YCharts

On the flip side, high multiple stocks are particularly prone to volatility as the market tries to figure them out. That price discovery process can lead to severe multiple compression if growth prospects are questioned. Layman's translation: The stocks can tank. Hard.

This most recent earnings season has been so brutal that it's shaken me to my growth-investing core in a rather demoralizing fashion. Maybe the grass is greener on the other value-investing side.

A tale of three sell-offs
Three of my personal Rule Breaking holdings -- Riverbed Technology (Nasdaq: RVBD  ) , MAKO Surgical (Nasdaq: MAKO  ) , and Universal Display (Nasdaq: PANL  ) -- have gotten absolutely crushed this season. Season's beatings, indeed.


P/E the Day Before Earnings

P/S the Day Before Earnings

Sales Growth (MRQ)

Next Day's Performance

Riverbed Technology 69.2 6.1 11.5% (29%)
MAKO Surgical NM 20.6 50.7% (37%)
Universal Display 575.1 29.6 31.5% (10%)

Sources: SEC filings, author's calculations. MRQ = most recent quarter. NM = not meaningful.

Riverbed's quarter was definitely disappointing, with product sales only inching up by a measly 4%. The company is looking to expand beyond its niche WAN optimization market and transition into a multiproduct company to reinvigorate sales growth. Riverbed still has some legitimate hurdles to clear, and investors have reason to question its lofty valuation, especially considering three out of the past four quarters have been disappointing.

MAKO's quarter was similarly disappointing, but in this case the punishment didn't quite fit the crime. RIO system sales came in light and the company reduced its full-year system sales guidance, although on the bright side it stuck with its procedure outlook. The business continues to grow, and one bad quarter doesn't ruin MAKO's momentum. A deeper concern was the credit facility agreement that MAKO may need to tap if it needs cash, despite CFO Fritz LaPorte's comments a quarter prior that the company wouldn't need to tap the markets for capital.

The Street plain got it wrong with Universal Display's quarter. A quarter of sell-side analysts hadn't properly modeled Samsung's licensing payments this year, inflating the consensus estimates and leading to a "miss" on revenue. Sammy is forking over $30 million this year, and analysts were expecting that in four even installments of $7.5 million per quarter. Instead, UDC is getting $15 million in the second and fourth quarters. Foolishly looking at the bigger picture, the compa