The Growth Stock Investment Approach

Key Insight

Every investor aspires to select stocks of companies poised to outperform the market over several years, with a 'growth stock' defined as one that has historically achieved this and is expected to continue doing so. While statistically identifying past outperformers is straightforward, the path to a guaranteed-successful portfolio by simply picking promising issues from such a list is fraught with complications. Firstly, common stocks with impressive records and favorable prospects command proportionally high prices, risking that investors may overpay for anticipated prosperity even if their judgments about the company's future are correct. Secondly, investor judgments regarding future growth are not infallible; unusually rapid expansion cannot be sustained indefinitely, and a company's increasing size often makes repeating past achievements more difficult, leading its growth curve to eventually flatten or decline.

A comprehensive study evaluating the performance of 45 'growth funds' over the decade from 1961-1970 revealed an average overall gain of 108%. While seemingly robust, this performance was only marginally superior to the 105% gain of the S&P composite and the 83% gain of the DJIA during the same period. Furthermore, in the specific years of 1969 and 1970, the majority of the 126 surveyed 'growth funds' actually underperformed both broad market indexes. These findings collectively imply that, on average, diversified investment in growth companies did not yield significantly outstanding rewards when compared to general common stock investments. This suggests that the average intelligent investor, even with considerable effort, is unlikely to achieve better results than specialized investment companies in this domain.

Consequently, it is advised against typical 'growth stock' commitments for the enterprising investor, especially when excellent prospects are already fully recognized by the market and reflected in a high current price-earnings ratio, for instance, exceeding 20. A notable characteristic of growth stocks, even those of large and established companies like General Electric and International Business Machines, is their propensity for wide market price swings, a tendency amplified in newer and smaller successful firms. This phenomenon underscores the significant speculative element present in the shares of highly successful companies. Although such companies may boast strong investment ratings and superior credit, the inherent risk of their stock is profoundly influenced by public enthusiasm; the more rapidly a stock's price advances relative to its actual earnings growth, the riskier the investment proposition becomes. Furthermore, truly substantial fortunes generated from single-company investments are almost invariably realized by individuals with intimate connections to the company, enabling them to commit significant resources and maintain holdings through all market fluctuations, a position generally unattainable for external investors.