The Secret to Buying Growth Stocks

Growth stocks are incredibly sexy. Perhaps it's their youthful vigor and their promise of bigger and better things to come. Maybe it's simply a fascination with their unexplored and untapped potential. Or it just might be the raw visual appeal of their tremendous curves -- of the potentially exponential profit growth variety, of course.

Whatever the reason for the primal attraction, it's easy to get tempted by growth stocks. Even so, their siren song can prove financially deadly to an unprepared investor. The big problem with growth stocks is simply that by the time you hear of them, everyone else with two nickels to rub together has, too.

You can't really think you're the first to desire a piece of the next big thing. As a result, you won't likely find tremendous growth trading at bargain basement prices. The market may not be perfect at predicting the future, but it's pretty darn good at reflecting current investors' expectations of things to come.

The drawback is that those expectations are set by other human beings -- people who are just as fallible and bad at guessing the future as any of the rest of us are. As a result, when a company misses or otherwise guides down the market's expectations, the consequences can be devastating. This chart shows a handful of companies whose shares have plummeted within the past year -- despite analysts' expectations that they will grow at better than a 25% annual clip.

Consider the example of Pacific Ethanol. The combination of high oil prices, Mideast instability, and Congressional meddling proved to be a tremendous boon for its stock as demand expectations skyrocketed for its flagship product. Yet for all the hype, fuel ethanol is still a commodity, and those high prices provided the perfect invitation for competition. Once that reality sunk in, so sank the shares of the former ethanol darling.

Enter through the back door
If you want to have a successful investing relationship with growth companies, the time to buy them is when everyone else has given up hope on their already successful businesses. Microsoft (NASDAQ:MSFT), for instance, was a bargain while its flagship Vista operating system got delayed -- knocking down expectations. Likewise, the Vista delay, along with the fact that archrival Advanced Micro Devices (NYSE:AMD) was cleaning its clock, put tech titan Intel (NASDAQ:INTC) on sale last year. Those pesky expectations!

Did you really think a scheduling delay would derail Microsoft? And did you honestly believe Intel would roll over and give up without a fight? At Motley Fool Inside Value, we knew that both those powerhouse businesses had the resources, know-how, and willpower to bounce back. That's why they were both selected as part of our market-beating service. When nobody else wanted them, they still looked wonderful to us. From an investor's perspective, buying a solid leader at a bargain price often beats buying a fresh face at a price that indicates that the world expects far too much of that young upstart.

If you've been hurt falling in love with growth stocks, then join us today at Inside Value to learn how to build profitable relationships with your investments. To protect yourself from being spurned any further, start your 30-day free trial here.

At the time of publication, Fool contributor and Inside Value team member Chuck Saletta owned shares of Microsoft and Intel. Microsoft and Intel are Inside Value selections. The Fool has a disclosure policy.