When you ask most investors for their favorite stocks, you’ll rarely hear them share a blue chip name like Johnson & Johnson, Kraft Foods or Wal-Mart. Instead they will tell you about some amazing growth stock that will be the next Google, Microsoft or Apple.
These investors believe that by simply buying stocks with the greatest earnings growth potential that they will make money. Sadly our research clearly shows this not be true…not even close.
In this article I will dispel the myth about investing in growth stocks just for growth’s sake. Instead I am going to shine the light on a path that has more consistently paved the way to profits.
Research Says…
I know that many of you are still shaking your heads in disbelief. Certainly I must be joking, right? Unfortunately, our research details, beyond a shadow of a doubt, the vast underperformance of most growth stocks over the past decade. Here are the results.
*The study had a 4 week rebalancing of stocks between 1/7/2000 and 2/18/2011
Stocks with the lowest projected growth rates actually generated the highest return of +9.5% per year. Each level of additional earnings growth came with decreasing levels of profits for investors. As we look at the most aggressive stocks, with 30%+ expected earnings growth, we find an embarrassingly low +1.3% return. This begs an obvious question…
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Exceptional Home Run Opportunity Ends 11:59 pm Saturday, March 26
A few strong Zacks Rank companies don’t stop with one positive earnings surprise. They have potential to keep surprising, quarter after quarter after quarter.
Weekend Wisdom readers are invited to learn how to ride these powerful stocks for 12, even 24 months – pursuing gains of +50%, +100%, +200% and more. Don’t miss the urgent video presentation that will be taken down Saturday, March 26.
See how to find home run stocks >>
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Why Don’t Most Growth Stocks Pan Out?
The early investors in growth stocks usually do quite well. They take the early risk when almost no one has heard of the company. As the company bangs out earnings surprise after earnings surprise, it gains more investor attention and a much higher share price.
However, at some point the company will be “priced for perfection”. Meaning that the PE gets too inflated as people are so sure that the good times will just keep rolling (think of a mini-version of the late 90s tech bubble).
Unfortunately, the exceptional growth rarely holds up over time. At some point, as the company tries to expand so rapidly, it will stumble. Even if that just means going from a 50% growth rate to a 40% growth rate. On the surface 40% still sounds great…but not to the investors who expected 50%+. So naturally the stock will tank. And tank fast.
I’m sure you’ve had a few of these stocks in your portfolio over the years. So I don’t have to remind you how quickly the losses add up. That, in a nutshell, is the danger of investing in growth stocks.
So What Does Work?
Certainly you could look at the stats above and conclude that stocks with lower projected growth rates generally outperform. That is true. But we can do a heck of a lot better than that.
The key is to find stocks that exceed expectations no matter the growth rate. Meaning that a stock that is expected to grow profits by 5% and ends up growing by 7% will do very well. Ditto for a stock expected to grow 30% that ends up at 35% actual earnings growth.
I know on the surface it sounds like you need a crystal ball to predict which companies will beat their earnings projections. Gladly, it’s actually much easier than you think because Len Zacks has done the hard work for you.
In the mid-1970s Len Zacks realized that stocks that had big earnings surprises continued to outperform the market over the next several months. This is what academics call the Post Earnings Announcement Drift…(yes, I know it sounds more like a medical problem than a means in which to invest in stocks 😉
But Len went a step further. He wanted to find indicators that would show him stocks more likely to have positive earnings surprises BEFORE they happened. If you could do that, then the odds of success were firmly stacked in your favor.
For the next several years, Len worked feverishly to discover these indicators. Gladly for all of us, he did find 4 leading indicators of future earnings surprises. Three of these measures are ways of looking at brokerage analyst earnings estimate revisions. The last being an analysis of past earnings surprises.
Each factor is potent by itself. Blending them together creates an almost unfair advantage for investors…that advantage is now called the Zacks Rank stock rating system.
Our Zacks #1 Ranked strong buy stocks have produced an average return of +19.2% over the same 11 year time frame as the study noted above. That more than doubles the average of the best stocks from that study. Combining Zacks #1 Rankings with growth stocks also provides exceptional returns. That brings me too…
Where to Find the Best Growth Stocks Now?
Our newest stock portfolio, Zacks Home Run Investor, seeks growth stocks that start hot and stay hot, leading to maximum long term profits. We do that by selecting Zacks #1 Ranked stocks that have the right stuff to bang out earnings surprise after earnings surprise.
I handpicked our growth stock strategist, Bill Wilton, to head this portfolio. How has he done so far? 11 of the first 12 picks are firmly in positive territory (the sole loser is down only 0.3%…nobody’s perfect 😉 To see these 12 companies and all the future home run stocks picked by Bill, then click the link below and view his video presentation now, so there’s time to take action before the midnight deadline, Saturday, March 26.
Wishing you great financial success,
Steve
Stephen Reitmeister
Executive VP, Zacks Investment Research
Steve is in charge of Zacks.com and all of its subscription services. He created the Zacks Home Run Investor to help investors find the best growth stocks for the long haul. And so far it has even outperformed our high expectations. Learn more about Zacks Home Run Investor.
