Can you stomach a growth portfolio?

Small-cap growth stocks are far more volatile than anything that's in the S&P 500 index, but it's worth your while to strengthen your stomach. Why? Well, don't you want to be like the man who bought Motorola when it was a tiny radio manufacturer back in 1955 and never sold? He multiplied his money many, many times over, and that one experience -- and others like it -- helped him become one of the best investors of all time.

But you didn't need to be investing in 1955 to profit from Motorola's amazing growth. If you had bought the stock as late as 1980 and held, through even the company's turbulent recent years, the investment would still have brought you a return of more than 2,100%, turning $10,000 into $221,000.

Those types of returns are precisely why you should not only stomach growth stocks but make them a part of your portfolio today.

The growth king
The Motorola man I mentioned above is the famous Philip Fisher, and in 1958 he wrote Common Stocks and Uncommon Profits -- a timeless book for all investors. His greatest contribution to growth investing may be his 15 Points. Though they won't shield you from short-term volatility, these points will help you achieve incredible long-term returns.

Here's the short-short version ...

  1. Great growth stocks must take advantage of a substantial market opportunity to profit. That means they will be both "fortunate and able." Of course, being fortunate and able requires many things, including an excellent industry position, competitive advantages, prudent uses of discretionary dollars, efficient models, and superior sales forces.
  2. Great growth stocks must have a balanced and transparent management team. A potential investor must be able to look at a company's leadership and believe that it has integrity, an ability to handle distress, and an insightful vision for the future.
  3. Great growth stocks must have outstanding accounting and disclosure policies. Anything less than excellence is unacceptable.

How do these qualities translate to significant shareholder return? Examine Fisher's investment in steel maker Nucor in the mid-1970s. This was a growth mover at the time that went from a relative pip-squeak to the second-largest American steel manufacturer by the time Fisher sold it.

Nucor embodied some of the very basic principles that Fisher espoused. For example, when many steel makers were concentrating on volume and turnout, Nucor focused on implementing new technologies into its production methods, making each of its plants smaller, more efficient, and most importantly, more profitable. And today the company still looks like a little brother compared with big players such as Posco (NYSE:PKX).

But again, you didn't need to be Fisher to take advantage. Even if you had bought Nucor stock in 1990, long after the company's initial move, you would have a fat 1,760% return on your hands. That's a 19% annual return compared with the market's 9%.

The next wave
I'm an analyst on the Motley Fool's Rule Breakers growth service, and I am constantly on the prowl for the best growth stocks out there. So with an eye on Fisher's most important lessons, here are three growth stocks that I believe have tremendous potential:

Company

Market Cap (millions)

Forward P/E

Long-Term Growth Estimate

LMI Aerospace (NASDAQ:LMIA)

$292

16

15%

Jos. A. Bank (NASDAQ:JOSB)

$629

12

15%

Take-Two Interactive (NASDAQ:TTWO)

$1,340

20

16%

Retailer Jos. A. Bank is easily the most recognizable name on the list. Businessmen often can be found milling around the racks of this apparel outlet. I'll pass on the style, but the numbers are certainly appealing. Compared with rival Men's Wearhouse (NYSE:MW), Jos. A. Bank sports a lower P/E alongside greater growth potential.

LMI Aerospace provides structural components to aircraft manufacturers. You may have never heard of the company, but as the rush builds to fill air travel demand and provide critical materials to the military, so too will this company. It sports a miniscule $300 market cap -- and has already risen nearly 70% so far this year. But if you're a believer in where this aerospace market is headed, LMI is an excellent way to get a piece of the action.

Take-Two Interactive is a serious player in the gaming business. The company's Grand Theft Auto franchise is notorious around the world and rakes in serious dough. But this company has a robust portfolio of games that it can build upon, many of which have serious potential. In the years to come, I look to Take-Two to challenge Electronic Arts (NASDAQ:ERTS) and Activision for gaming supremacy. This is my favorite company of the lot.

More where those came from
These are three of my favorite growth picks, and I look forward to seeing them flourish. Fisher's principles which are elemental in my own approach are also a big part of how we research at Rule Breakers -- where growth is king.

If these principles agree with your style, then I advise you to try the service free for 30 days without obligation. We're thumping the market average right now by nearly 22 percentage points. You can see all of our research and recommendations immediately upon joining, and there is no obligation to subscribe.

This article was first published July 30, 2007. It has been updated. 

Rule Breakers analyst Nick Kapur owns no shares of any company mentioned. Posco is an Income Investor selection. Electronic Arts and Activision are Stock Advisor recommendations. The Motley Fool has a disclosure policy.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.