Wednesday, December 4, 2013

Caution: Investing in Growth Stocks May Cause Serious Injury

When an exam question implies that investing in growth stocks is riskier than investing in value stocks, it's not necessarily saying that growth stocks are issued by companies likely to melt down. The real risk of investing in growth stocks is that they are priced for perfection and, therefore, super-sensitive to any tidbit of bad news. For example, I'm holding a few hundred shares of KKD, which is trading at what seems a crazy-high PE ratio of about 80! The other day the company announced that it had met Wall Street analysts' expectations, had increased their earnings-per-share by 33% compared to last year, with sales/revenue up 6.7%. What happened to the stock? It dropped about 25%.
Huh?
Yes. If a stock is already pumped up with such a high earnings multiple, even a lack of awesome news can cause a sudden and significant drop in market price. Luckily, I already knew this and used a sell-stop to take a $13,000 profit during the previous earnings announcement.
But, with value stocks--Pfizer and GM--I never think about sell-stop orders. I just follow the company and hold the stock unless there is clearly disaster up ahead.
And, that's the difference between investing in growth stocks versus value stocks. With growth stocks, if the news isn't really good, the share price can plummet. That's because good news has already been baked into the inflated stock price.
With value stocks, as long as the news isn't terrible, the market price usually hangs tough--since bad news has already been priced into the stocks.Pass your Series 65 or 66 exam

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