Growth stocks, with their high PE ratios and outsized EPS expansion, can be an important part of a portfolio. When these stocks are beating expectations, little can stop them from adding incredible gains, easily crushing their more value-oriented counterparts.
Yet growth stories inevitably have to end, and when the narrative that propelled these securities higher is over, the results can be disastrous in a very short time period. This can be particularly true for investors who got in late on high flyers and missed out on much of the gains, only to be there at the fall.
Two great examples of this phenomenon over the past few years have been Chipotle Mexican Grill (CMG - Analyst Report) and Apple (AAPL - Analyst Report). From April 2011-April 2012, CMG added about 54% while AAPL surged by an even more impressive 77%.
Unfortunately, more recent trading has produced at least a short-term top for both stocks, plunging both into bear territory. AAPL is now down over 20% from its all-time high about two months ago, while CMG has fallen by a similar amount.
In both cases, solid firms that are still growing strong failed to live up to expectations and seemed more uncertain about their outlooks too. This was enough to cause investors in both stocks to sell off and book their longer-term gains in the two firms, but undoubtedly it also helped to crush those who were late to either growth story.
Not only that, but for both CMG and AAPL—along with dozens of other former high flyers out there—sentiment turned on a dime. What was seemingly a never-ending growth story one day, turned into a questionable one more or less overnight, adding to broad investor frustration over these types of stocks.
So the question is; how do you prepare your portfolio when dealing with these types of companies?
Do you avoid these securities no matter what—despite the incredible returns they can provide—or do you have a system for avoiding some of the pain that can come when growth stocks falter?
Personally, I tend to avoid these securities as I am too afraid of getting in at the top, but what about you? Let us know what you think in the comments below!