Monday, February 22, 2010

Growth Stocks: Are They Safe Investments?




Growth Stocks - A Bad Rep?
In a previous post about fundamental analysis, I talked a little about what I term "reckless investing".  After the dot-com bust in the early 2000s, growth stocks have become somewhat a synonym as "reckless investing".  Why?  In the years leading up to the bust, people believed in the internet revolution, where the internet and e-commerce would change the way of life.  This was a typical "this time is different" mentality.  By the way, if ever you hear someone say, "this time is different," run for your life!  Things will almost always be the same, because human greed (one of the 7 deadly sins) is very, very consistent.  Even renewable energy will eventually turn into a bubble.  Anyway, I digress.  

So, what spawned from the dot-com bust?  People were very afraid of growth stocks...you know, stocks like Google (ticker: GOOG) and Apple (ticker: AAPL)...catch my drift??  So, instead, a lot of people in the US invested in safe investments, like real estate.  As a Chinese-Canadian, I am deeply influenced by my Chinese roots.  One thing that my dad had always advocated was that you can never go wrong buying real estate, because it's something tangible and people always need to live in a home.  Wow...it's a good thing he didn't invest in real estate and live in the Nevada in 2008.  So, fast forward a few years to 2007 and you know something is brewing.  People kept on talking about subprime mortgages...what the heck are those?  I'd like to get a mortgage at rates lower than the prime rate, right?  Sorry, that prime is very different.  Everyone now knows that subprime refers to risky borrowers who are probably going to default if something went bad.  And bad it went!  We all know about that fiasco now after living through what will be termed by historians as the Great Recession.

So, back to growth stocks.  In and of themselves, growth stocks are neither a good nor bad investment.  There are some awesome growth stocks, and there are some very poor growth stocks.  How do you define a growth stock anyway, you ask?  Investopedia gives the definition as, "Shares in a company whose earnings are expected to grow at an above-average rate relative to the market."  I personally like growth stocks because they are typically technology stocks and I'm a geeky guy.  My portfolio is almost entirely made up of growth stocks, and hopefully, I'm not doing some reckless investing!

Can Growth Be Sustained?

Let's take a look at my darling, First Solar (ticker: FSLR).  It's a relatively new company in the solar photovoltaics sector.  It IPOed in 2006 at around $25 and quickly grew 10x in about a year's time.  Holy smokes!  I wish I knew about this company when it IPOed!  As the recession hit, its stock dropped back to double-digits for a while.  Now, it's sitting at around $112 at the time of writing. The question now is: will it become another Nortel (ticker: NT...now non-existent due to bankruptcy)?  There are doubters in the room...I can feel it.  Some, as a result of the dot-com bust, will never put their trust in growth stocks again.

All arguments aside, let's look at a mystery growth stock.  Below, you will see the first 2 years' performance of the stock.  It IPOed at around $0.10 and quickly grew to $0.55 in 2 years - simply spectacular performance.  Then, it hit a bump and dropped back to $0.30.  What is its future?  Is growth sustainable for this company?  Some will argue that the price rose too much, too quickly.  No stock can sustain that type of growth in the long term.  This 45% drop in price is just a signal of things to come.


Ok, this is an investing blog, not a mystery novel.  So, I will save you the suspense.  The stock is Microsoft and the years were 1986-88.  Below is the chart of its entire history.  As we all know, even if you did buy at the "peak" of $0.55 (this price is split-adjusted), you would have made approximately 60x your initial investment if you held and sold in 1999.


What's the moral of the story?  There will be some stocks that will grow, and grow, and grow.  Don't be disheartened if you find a growth stock with a bright future, but is experiencing a pullback.  They may resume their growth in the very near future.  You will need to identify these companies.  For that, see my post on megatrends.  By identifying a megatrend, you can be sure you're in for some awesome returns.

A Tale of Three Stocks

Don't believe me?  Let's take a look at the oil megatrend.  Oil is the single most important energy source of the world today.  To say that it was a megatrend almost does not do it justice.  The stocks of the 3 of the biggest oil companies in the world (Exxon Mobil, British Petroleum, Chevron) are plotted above.  BP has the worst performance, but it matched the growth of S&P 500 in the same time period, which is still fairly good.  Exxon Mobil's growth was simply super.  Investing $10K in 1970 would have resulted in $500K portfolio at the stock's peak.

This again confirms my take on megatrends.  You don't really need to be 100% on your stock selection.  If you can find a megatrend, the successful companies in that industry will benefit, although some more than others.  Of course, finding the best one will give you that extra boost.

Back to First Solar
The funny thing about First Solar is that its stock is getting a beating because...wait for it...the future is uncertain.  What?  When was the future ever certain?  Investors are scared because German feed-in tariffs may be cut, too many solar companies are ramping up, the global recession is still affecting solar projects, yadi, yadi, yada.  Yet, they don't look at the other side of the story.  China is planning on a 2GW solar farm with FSLR as supplier and it is imminent that the US will pass an environmental bill, etc.  Again, when others are fearful, you want to be greedy!

Take a step back and look at the megatrend.  Renewable energy is the future.  There is absolutely no doubt in that.  And you know what the best thing is about that?  It's the fact that by investing in renewable energy, we are fulfilling the stewardship that God has placed on humanity for the care of the Earth.  Investing ethically and making some super returns is one of the best combinations you can get in the world of investing!