According to a study conducted by Bank of America/Merrill Lynch over a 90-year period, both growth stocks and value stocks have delivered double-digit returns for investors. Based on the data, growth stocks are up an average of 12.6% annually since 1926, while value stocks have jumped 17% annually in value.
On the surface, it would appear as if value investing is the way to go, but since the end of the Great Recession, growth stocks have widely outperformed value stocks, probably a result of the Federal Reserve's dovish monetary policy that's allowed for cheap access to capital. But, just because growth stock investing has led to double-digit returns over the past nine decades doesn't mean a profit is guaranteed.
We asked three of our Foolish contributors to weigh in on what they believed to be the worst investing mistake you could make when investing in growth stocks. Here's what they had to say.
Chasing growth stocks before an industry is established
Sean Williams: I believe the biggest concern with growth stock investing is that investors have a habit of chasing new technology before it's had an opportunity to establish itself.
Perhaps the best case in point is the 3D printing industry. We only need to pull up a 10-year chart of 3D Systems (DDD -2.82%) and Stratasys (SSYS -0.62%) to get an up close look at how rapidly their valuation inflated and deflated over just a few short years.
On paper, the 3D printing industry looks like a solid growth story -- and for many years, it was. Between 2009 and 2014, 3D Systems' revenue almost sextupled to $653.7 million, while Stratasys' revenue rose more than sevenfold to $750 million. The potential for 3D printing seemed to be without bounds. It could presumably be used to create prototypes to speed up the innovative process for industrial companies, while saving money in the process since companies wouldn't be forced to buy prototypes in bulk. 3D printing also has intriguing medical applications, with the possibility that 3D printers could create transplantable organs, or other devices. Nearly every industry had a presumed purpose for 3D printers -- and yet the bubble burst for both 3D Systems and Stratasys.
Why? The fundamental answer you'll hear from the companies themselves and Wall Street pundits is that corporate spending slowed, thus hurting new orders. But there's more to it than that.
To begin with, both 3D Systems and Stratasys had acquired companies at a breakneck pace for years. While M&A is a great strategy to pack on top-line growth, it can take time for businesses to mesh and synergies to be realized. The recent slowdown in top-line growth, which has also been attributed to poor product rollout execution, could be rightly blamed on 3D Systems and Stratasys trying to gel too many of their purchased components at once.
More importantly, growth investors never gave either business a chance to develop an identity. They just saw big flashy numbers surrounding 3D printers and dove in feet first despite the water being ice cold. While waiting for an industry to establish itself sometimes means missing out on an initial surge in share price, it also means investing in companies that could be far less likely to swan-dive like 3D Systems and Stratasys have.
Easier said than done
Daniel Miller: Investing in growth stocks isn't for the faint of heart, as the swings in price can be huge. And while there's plenty of important things to watch -- such as how leveraged the young company's balance sheet is, or how much cash it's burning through annually -- arguably the most important thing should be the simplest: controlling your emotions.
That's important because growth stocks make wild and abrupt swings in stock price, and if you're constantly refreshing the price on Yahoo! Finance, it's going to be difficult to stay invested for the long haul – and that's what you want to do with winning growth stocks.
That's especially true because picking a winning growth stock for the long haul means you'll likely be holding this for a decade, or hopefully forever, and will see many cycles of the stock market. That means some dips will be devastating, even if the company's underlying business thesis is still very much intact.
Perhaps the difficult aspect of "controlling your emotions" is actually on the flip side of the coin: selling too early! If you do pick a winning growth stock and it doubles, quadruples, or something even more jaw-dropping, it can become tough to hold on rather than cashing out and redistributing those funds to other new ideas -- take this $802,179 mistake to heart.
My advice to help control emotions is to make a detailed checklist and investing thesis for your growth stocks -- or all of your stocks, really. Looking at one quarterly report compared to the prior-year result doesn't provide context, it merely incentives short-sighted reactions. Keep track of the balance sheet, revenue growth, margins, and cash burn every quarter over the long term, and let that tell the story, rather than knee-jerk reactions to a bad quarter or fear during a recession.
Growth stocks or otherwise, this mistake will hurt you
Jason Hall: In my experience, one of the biggest mistakes people make when investing is the same, whether it's growth stocks or otherwise: not really understanding what they own. The sad fact is, too many investors buy a stock based on an idea, tip, or reading the name in an article, but they don't actually take any further steps to investigate the company, industry, or competitors, or do any other due diligence before putting their money on the line.
And frankly, this is a key thing that drives the two huge mistakes my fellow contributors write about. If you don't invest any time to learn about what you own, you leave yourself exposed to letting your emotions take control of your investing decisions, as Dan wrote about, or running out of patience if you don't know how things are playing out with the bigger picture, as Sean discussed. Bottom line: The root cause of these kinds of investing mistakes is often failing to put in the necessary time to know what you're actually investing in.