This earnings season we have seen what can happen when growth stocks report earnings: there can be some instant big moves in both directions. That is the risk you take when investing in this type of company that is, by all accounts, overvalued but supporting a high P/E with it’s accelerating growth. Why are investors so inclined to pay more for pure growth than they are for stability and solid future earnings? It truly is a mystery.
Chipotle (CMG) reported earnings this week and while they continued to grow, it wasn’t fast enough for investors who promptly bid the stock down by 50 points. This is NOT the type of stock chart you want to wake up to!
But last week saw some of the most popular growth stocks rocket higher after what was a terrible 2014 for them. Netflix went up $60 on the news that significantly more subscribers were signed up last quarter than analysts had projected. Amazon shot up $43 on news that they finally turned a profit, even though it was small. And finally Google went up $32 (over three days) on news that things aren’t quite as bad as they have been in quarters past.
All three of these companies (NFLX, AMZN, GOOG) seem to be investor favorites that get a pass more often than not when it comes to earnings. Blinded by growth (or the prospects of it), investors have for years been willing to buy these stocks mostly on the promises made by company officers. As mentioned, 2014 was a down year for all three and it seemed like the tide might be turning and investors were getting more picky. But this last response to earnings shows that investors still want any excuse to buy the stocks and THAT is what makes growth investing so exciting.
The rewards can be great for growth stocks but the downside is that sentiment can turn on a dime. Analysts estimates are key in that the companies have to handily beat them or issue guidance that is spectacular. If they don’t, investors will turn on them quickly. Growth stocks can be like roller coasters and while the rewards can be high, you have to know when to get out before their growth slows down.