When the market turns south, growth stocks can be the first to crack. That is why you have to be very careful when investing money in them. It doesn’t take much to send a high flyer over the top and back down in a quick descent.
Usually, high growth stocks have P/E ratios that are higher than their peers. Revenue might be high but profit is often low. Investors keep plowing money into these stocks because they hope the companies will be able to monetize the growth and the payoff will be big. But that can be a problem when any hint of trouble surfaces.
The two things that keep growth stocks going higher are management’s optimistic forward projections and consistent growth quarter after quarter that back up those projections. For a stock to do really well, the company can’t miss on any earnings report. One miss, one mistake, one miscalculation and it might mean a serious setback for the stock.
One mistake that seriously damaged Netflix for several years happened in June 2011 when CEO Reed Hastings said they were going to raise prices on streaming and separate the DVD business into an additional subscription. The stock tanked and it was a public relations nightmare that was talked about for months in social media. No company or investor wants a chart like this:
If you owned Netflix during the middle of 2011 and weren’t paying attention to it, what a shock you would find later in the year when you looked at your portfolio. And news like that isn’t the only thing that can take down a growth story. Usually it is slowing earnings because growth expansion is what investors really want who buy this type of stock. They are an impatient lot of speculators who have a low tolerance for anything normal when it comes to future prospects.
When you invest in growth stocks, you must constantly monitor industry news, company news, earnings calls, and make sure you have your pulse on what the market thinks of those stocks. Having more risk in them than value stocks, growth stocks tend to move quickly to both the up and down side. If you want to be able to get out before your whole gain is gone, you can’t just sit back and treat them like long term plays.
Growth is a popular metric and one that many look at when picking stocks. But the kind of growth that can double or triple a stock is hard to find and often comes with increased risk. Managing that risk by keeping close tabs on your stocks is imperative if you want to minimize the losses on the stocks that can’t sustain that growth.