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 (NYSE: MOT) 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, even through the company's turbulent recent years, the investment would still have brought you a return of 1,225%, turning $10,000 into $132,500.

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

The growth king
The Motorola man I mentioned 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 steelmaker Nucor in the mid-1970s. Nucor was a growth-mover at the time, and it went from a relative pipsqueak 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 steelmakers 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 important, more profitable. And today the company still looks like a little brother compared with big players like Arcelor Mittal.

But you didn't need to be Fisher to take advantage. Even if you had bought the stock in 1990, long after the company's initial move, you would have a fat 1,874% return on your hands. That's a 17.9% annual return, compared with the market's 7.5% annual gain.

The next wave
I'm an analyst on the 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 I believe have tremendous potential:


Market Cap

Forward P/E

Consensus 5-Year
Growth Estimate

Take-Two Interactive

$1.2 billion



MercadoLibre (Nasdaq: MELI)

$1.5 billion



Under Armour (Nasdaq: UA)

$2.2 billion



I've been tooting the horn of Take-Two for a while now and am glad to say that it's a recent addition to my personal portfolio. What convinced me finally to get some skin in the game? Well, I see evidence that this bad-boy of the gaming world is back on track after years of mismanagement and poor strategy. Take-Two has a competitive advantage in its intellectual property. Just look at blockbuster franchises such as Grand Theft Auto, the company's 2k sports label, and recent deals with icons such as Nickelodeon. I expect big things from Take-Two in 2008 -- the year when it should challenge bigger names such as $7 billion Activision.

MercadoLibre isn't just the eBay (Nasdaq: EBAY) of South America. Well, actually, that is exactly what it is. But considering this company has the backing of the North American bidding superstar it's often compared to -- as well as footholds in Argentina, Brazil, and Mexico -- I submit that MercadoLibre has the opportunity to achieve massive growth. The stock is trading at nearly 200 times trailing earnings, so many would suggest that these expectations are priced in already. But I'm not convinced -- MercadoLibre is the only show in town and the sky is the limit.

Under Armour is no surprise to anyone at this point. But growth hawks have battered this stock from a high of $73 down to the mid-$40s. Why? I have no idea. Brand quality and innovation are going to take this company from its miniscule valuation of $2.2 billion upward and onward, and I think you should consider the stock today. Eventually, Under Armour will challenge $30 billion Nike (NYSE: NKE) worldwide.

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 more than 13 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 excitedly owns shares of Take-Two Interactive. Take-Two and Under Armour are Rule Breakers recommendations. Activision and eBay are Stock Advisor picks. The Motley Fool has a disclosure policy.