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!

Is the Bull Market Over?

There's been a lot of negative talk lately about the market.  First, Obama wanted to proposed a number of reforms to the banking industry, then it seemed Ben Bernanke might not be re-appointed as Federal Reserve Chairman (by the way, he just got re-appointed today), jobless claims and durable goods numbers weren't great, and finally, Steve Jobs showed us a re-sized iPod Touch and called it the iPad.  The market responded by droping almost 6% in 7 tradings (S&P 500 closed at 1150 pts. on Jan 19 and only 1085 pts on Jan 28).

What does this mean?  Is the bull market over?

Maybe...But Not Likely
Before we begin, let's review what the definition of a bull market is.  The most common definition is that a bull market has occurred if the market has risen by more than 20% from the previous bottom.  Conversely, a bear market is when the market has fallen more than 20% from the previous top.

As you know already, I like looking at numbers.  Let's look at some stats.

1. From 1949 to 2008, the average bull market lasted 45 months.  The shortest lasted 15 months.  We are in our 10th month of the current bull market.  So, I would guess there's still some steam left in this bull.  I know these are special times...but I'm sure things looked pretty grim during the Korean War, the Vietnam War, the 1973 Oil Crisis, 9/11, etc.
2. Ken Fisher noted in his book The Only Three Questions That Count that whenever government deficit hits a high, the stock market is bound to do well.  The reverse is also true, that when government deficit declines, the stock market will fare worse.  It sounds a little counter-intuitive, but facts don't lie.  I have overlaid the graph of S&P 500 (red & green) with the graph of the federal deficit of the US (blue).  Obviously, his theory doesn't work all the time, but let's take a look
   - 1968 high spending, followed by 1968 stock market peak
   - 1969 surplus followed by 1970 bear market
   - 1971 peak spending followed by bull market until 1973
   - 1974 low spending followed by 1974-1975 market bottom
   - sustained high spending in the 80s drove the market a long bull market, as with the 90s
   - 2000 peak in surplus followed by 2000-2002 bear market
   - 2003-2004 high spending followed by long bull market until 2008
   
   
   
   So, we should be happy that the government have spent so much of our money!  Sounds kind of backwards, doesn't it?  I'm not the expert economist...so why don't you read Fisher's article on this?  He actually talks about debt, but deficit essentially tells you the direction that debt is going...so we would arrive at similar results.
3. Ken Fisher also notes that bear markets don't occur overnight.  It takes a few months for it to happen.  Don't believe me?  Take a look a our previous bear market.  In July 2007, S&P 500 hit around 1550 points.  It reached that level again in October, but wasn't able to break through by much (this is called a "double top" in technical analysis language, by the way).  Then, the bear market was confirmed in July of 2008 after it dipped 20% below 1550 points (1240 points) in July 2008.  Then the market fell off the cliff in September and October of 2008.  This was more than 1 year after the peak of the bull market!
   
   
   
   What we're seeing now is a correction.  Correction usually occurs quickly and typically has some story behind it to make it look real.  Don't fall for it.

So I Should Buy, Right?

Well, that's always your choice, but I have added to my positions this past week.  As Warren Buffet says, "Be fearful when others are greedy and greedy when others are fearful."  What do the headlines say these days?  Recovery is sluggish...unemployment is still high...national debt is unsustainable...I would say people are still pretty scared right now.  It's when you see people, who have no idea what stocks are about, investing in stocks that you need to be scared.  I don't think we are at that point yet.

I like listening to those who are successful, those who are proven, the likes of Warren Buffet, Peter Lynch, Jim Cramer, Ken Fisher, and Phil Town.  I don't like listening to pundits who are trying to make a living "punditing".  Last time I checked, pundits weren't the best investors around.  If you don't trust Buffet or Fisher, at least trust the numbers.

Google Gets Interesting!

Google has been making some headlines this past week.  If you haven't already heard, Google made a statement regarding their business in China.  It addressed two issues regarding the Chinese government.  First, to operate as a search engine in China, it must filter its search results according to the local censorship laws.  Second, a number of Gmail accounts of Chinese dissidents and human rights advocates were hacked, apparently by the Chinese government or an organization backed by the Chinese government.  In essence, Google's statement said that they were fed up with China's violation of human rights, will no longer censor its search results, and is threatening to pull their business from the country.

Are They for Real?
As you may have guessed, many pundits have commented on Google's real motives.  Among some of the more improbable was that since Google trailed Baidu in popularity in China and saw no real way of gaining ground, they were using human rights as an excuse to exit this market.  Are you kidding me?  Just because they were trailing in market share, their business was still profitable.  It's like Pepsi saying, "we can't gain market share from Coke in the US, so we're discontinuing our operations there."

So, what's the real motive behind Google's bold move?  Henry Blodget wrote a great post on what he thought and I could not agree more.  I'll do a quick summary here for those who don't have the inclination to read Blodget's post.  A few years ago, Google entered the Chinese market, but only to abide by the Chinese censorship laws.  Many pundits criticized Google for succumbing to the evil clutches of the Communists in return for doing business in China.  Between now and then, Google had acquired about one fifth of China's market, which is by no means a small number, with the total number of internet users at just under 400 million. Google patiently waited until their business was significant to the Chinese people to try to make its move.  Google has had a history of making its voice heard regarding political issues (read my previous post on Google), and this is no different.  It's main motive, I believe, is to put pressure on the Chinese government to relax its censorship laws and to respect the human rights of its citizens.

Will Google really pull out of China?  I don't think so; there's too much money in China to do that.  But it is a move to mobilize the Chinese people, other foreign companies operating in China, and even the US government to engage China on this issue.  I don't know how this will play out, but keep your eyes open.  It'll be an interesting one.

What's My Take?
For those who have read my previous post on Google, you know I love the company but is at odds with some of its political opinions.  However, I really admire their top dogs this time around.  To threaten to leave this most lucrative market is a bold move, but for the reasons of pushing human rights makes it an even more laudable act.  Obviously, Google's stance cannot be 100% altruistic (perhaps they're trying to gain some good PR and free advertising, etc.), but this move is nevertheless quite risky for them.

Well, life is never black-and-white.  While I despise Google's support for same-sex marriage, I admire their courage in standing up against the Chinese government.  What I do think is that Google really tries to live by its motto, "don't be evil."  At least their intention is good.  Some of their opinions are just muddled by the liberal thoughts that's so prevalent in North America today.

Final thought: Can someone please make converts of Eric, Larry, and Sergei (CEO and co-founders)?  I cannot imagine what impact Google would have on the world if it were run by three devout and morally upright Catholics!