The trend line for most growth investors is both short and ugly. I would estimate that most growth investors have a career that does not exceed three years. Those who survive learn to change their investment strategy to a more balanced approach.
The first thing that the newbie growth stock investor quickly learns is that the corrections on the super stocks that he thinks are going to make him rich are horrific. After getting killed a few times,a wise old hand introduces him to the charms of the stop-loss order. He is ecstatic. This is the answer to his prayers. The grim reality is that this is like progressing from marijuana to heroin.
A stop-loss order is an automatic order given to your broker to sell your position if the stock falls to a predetermined price. The stop loss-order is almost always set at one of three price points. It is set at either 5%, 7.5% or 10% below the current market price. The most common price point by a country mile is 10% below the current market price. A price point of 5% or 7.5% below the market results in your being stopped out every time you turn around. This is regarded as being intolerable by most investors. There is a theoretical problem with the stop-loss order which most users never discover. The problem is that they become an addictive crutch and slowly destroy the judgment of the investor.
Let's now take a look at the two alternatives that the super stock investor has available to him.
After all why klutz around with mere growth stocks when you can get rich quicker with super stocks.
We can quickly dismiss the now allegedly discredited buy and hold strategy. Or so it is now widely assumed. That leaves us with just one tool in our tool box, the stop-loss order.
Let's take a look at the five-year performance of $10,000 invested in some of today's most highly regarded super stocks.
Amazon = $24,100
Apple = $102,400
Google = $55,200
Hewlett Packard = $25,300
Oracle = $22,300
Research in motion = $37,500
S&P 500 Index = break even
One thing that is immediately apparent is that these super stocks delivered the goods in comparison to the break even performance of the S&P 500 Index. Other super stocks did not live up to their reputation. Such as Cisco, Intel and Dell and are not included in the above list.
Bear in mind however, that this performance was only available to the now despised buy and hold investor. The $64,000 question is what would our shrewd, super sophisticated, trend chaser with his vaunted 10% stop-loss discipline achieve.
In the last five years, Amazon has had 14 corrections of 10% or more. Six of these corrections were of 10% plus, five corrections of 20% plus, two corrections of 30% plus, and one very ugly correction of greater than 40%.
Apple also had 14 corrections of 10% or more. It had 8 corrections of 10% plus, four corrections of 20% plus and two brutal corrections of 40% plus.
Google had 15 corrections of 10% or more. Eleven corrections of 10% plus, two corrections of 20% plus, one correction of 30% plus and one brutal correction of 40% plus.
Hewlett Packard is our star performer. It had only seven corrections of 10% or more. Five corrections of 10% plus and two corrections of 20% plus.
Oracle had twelve corrections of 10% or more. Nine corrections of 10% plus and three corrections of 20% plus.
Research In Motion is of particular interest. According to the most recent issue of Fortune Magazine. It is ranked number one in the magazine's top 100 list of the fastest growing stocks over the last three years, Not just in the United States but in the world. This proven super stock has had nine corrections of 10% or more. Three corrections of 10% plus and four corrections of 20% plus, one correction of 30% plus and one horrific correction of 70% plus.
How about that, pick the number one stock and get a 70% loss for your effort! Actually it was 72%, but who is counting. Of course this was quickly followed by a powerful snap back rally of 65%.
The S&P 500 Index did the job it was created for. It had only four corrections greater t 10% plus. Two corrections of 10% plus, one loss of 20% plus and one loss of 30% plus.
I think it is safe to say that these brutal corrections on proven, high performing, super stocks is not exactly what the typical growth investor was expecting. Remember these stocks were selected because thay had gone up from two to ten times in value in the last five years.
Compared to breakeven on the S&P 500 Index. These stocks are the holly grail of growth investing. They are proven winners.
According to growth investor stock lore, the wise investors in these stocks should have been rewarded with fabulous profits. The buy and hold investor who stuck it through to the end was indeed rewarded handsomely. I have grave doubts however, about the performance of the dancing slick investor with his stop-loss orders and his easy assumption that there is some rational means of timing stock swings. In more than forty years of looking, I never found any method that out performed a coin toss over the long run. Though I grant you that there are many methods that appear to work in the short term. Until they blow up in your face.
I submit to you that the typical dancing slick, growth investor with his stop-loss orders does not get rich in super stocks. His typical experience is to repeatedly get blown out of his positions every time his stop-loss orders are triggered. Taking a 10% loss each time. In due course his mangled body is dragged out of the arena floor feet first. The shell-shocked victim of one too many 10% losses. After all how many 10% losses can you take? Think about it!
At least that was my experience until my conversion.
The astute reader will recall that there is one strategy that does work. Buy and hold. The problem with buying and holding super stocks is that you need nerves of steel. I doubt if more than 10% of the investing public has what it takes to make this strategy work in the growth stock arena.
There is of course an alternative strategy. The strategy, which I advocate. Conviction investing with a long-term bias in contrarian-value plays. In more than four decades of speculating in the blood-splattered battleground that they call a stock market. It is the only strategy that I have ever found that works consistently, but only if you hold on for at least two years. Nothing works if the holding period is less than two years and I have the battle scars to prove it.
The essence of this strategy is that you are buying stocks that are residing in the gutter. That are current bargains based on today's price and not on tomorrow's price. When you buy growth, you are paying a premium, often a vast premium over its current intrinsic value. A premium that is based on the always-chancy assumption that the current superior growth rate will be maintained. A growth rate that in many cases must be maintained for five or ten years to justify today's extraordinary price.
Fred Carch is the author of Forty Years A Speculator.
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