Riddle me this, savvy investor: When is good news actually bad?
By way of an answer, consider the likes of Microsoft
So what, exactly, is the problem? Call it the rosy scenario syndrome: Analysts expect double-digit earnings growth for each of the aforementioned stocks over the next five years.
Isn't that good news?
In the abstract -- and if the analysts actually 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 big-picture economic data or industry-specific news comes along and mucks up the rosy growth story, relative high-fliers can head south in a hurry.
Which isn't to say you shouldn't own them. Companies with heady growth prospects are nothing to sneeze at, particularly if you've got a stomach for volatility. But even if you consider yourself a regular investing Evel Knievel, 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 tamp down wild performance swings.
Two for the price of one
But not just any fund will do. As the Fool's resident fund geek, I'm on the lookout for:
1. Strategic tenacity: With growth investing largely in the doldrums ever since the market melted down back in early 2000, I'm especially interested in growth funds with managers who have stuck to their guns during the downturn, snapping up the kinds of 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 on the cheap.
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 all too easy to become overly wowed and fall prey to "irrational exuberance." (See the late 1990s for the gory details.) With that in mind, I 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 I want to beat the market and get a good night's rest, I favor managers who run intelligently diversified portfolios. I'm not averse to funds that pack considerable sums into individual names or certain areas of the market. At the same time, I wouldn't advise diving whole-hog into, 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 by a double-digit margin as I type. And yep, we've zeroed in on a clutch 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 go, and remember: Even Evel Knievel eventually met his Snake River Canyon. If you'd like to avoid a similar fate as an investor, top-notch mutual funds make the ideal vehicle.
This article was originally published on Jan. 16, 2007. It has been updated.
Shannon Zimmerman runs point on the Fool's Champion Funds newsletter service, and at the time of publication didn't own any of the securities mentioned above. Microsoft is a Motley Fool Inside Value recommendation. UPS is an Income Investor pick. You can check out the Fool's strict disclosure policy by clicking right here.