Growth Stock Investing In 3 Easy Steps
Summary
- First, growth versus value is discussed, including comments about the market versus Berkshire Hathaway.
- Second, portfolio allocation is reviewed, in light of putting money to work with growth stocks, not just value stocks and dividend stocks.
- Third, valuation is always a consideration, but the metrics are not necessarily the same for all types of stocks - examples are provided.
- Fourth, a "tried and true" investment approach is explored, to be layered on top of portfolio allocation and valuation.
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Setting The Table
At this point in time, Berkshire Hathaway (BRK.B) (BRK.A) is still my largest position. Of course, I trust Warren Buffett quite a bit and I appreciate the Owner's Manual. I'm especially fond of these points:
Charlie and I hope that you do not think of yourself as merely owning a piece of paper whose price wiggles around daily and that is a candidate for sale when some economic or political event makes you nervous. We hope you instead visualize yourself as a part owner of a business that you expect to stay with indefinitely, much as you might if you owned a farm or apartment house in partnership with members of your family. [Emphasis: Author's]
I started buying BRK.B back in June 2011 and the results have been satisfactory, as I can generally represent here:
But, I'm afraid I would have been better off buying the S&P 500 (SPY). Furthermore, I am not convinced that BRK.B will strongly outperform SPY from this point forward. It might, but there aren't any strong catalysts in place. In fact, there's likely to be greater volatility and perhaps increased risk as Buffett and Munger taper off, so to speak.
I bring all this up because as time goes on, and I've continued to buy value stocks and dividend growth stocks, my strongest positions are those based on growth. Putting this another way, I love value and I love dividends, but growth stocks are the special "kicker" juicing true outperformance in my portfolio.
Therefore, in this article, I'll explain how conservative investors - like me - are finding a rational way to buy growth stocks, and stay sane. After all, buying growth stocks can be very challenging since all the traditional measures are thrown out the window, e.g., P/E, P/B, dividend yield, and so on.
Here's how the article will play out. First, growth versus value is discussed. Second, portfolio allocation is reviewed, in light of putting money to work with growth stocks, not just value stocks and dividend stocks. Third, valuation is always a consideration, but the metrics are not necessarily the same for all types of stocks - examples are provided. Lastly, a "tried and true" investment approach is explored, to be layered on top of portfolio allocation and valuation.
Step One: Pick An Allocation To Growth
I have spoken with many conservative investors over the years and it's very clear that avoiding risk is a major concern. Make no mistake. I'm in this boat too, with a real disdain for risk, so I continue to invest in more traditional value plays, and dividend stocks.
I'm going to recommend that some percentage of a portfolio should be allocated to growth exactly because of risk. That is, without strong growth, investors can be left behind. Consider how growth (VUG) has beaten value (VTV) and dividend appreciation (VIG), via these three Vanguard ETFs.
Of course, I understand this might not continue. This is merely a view in the rearview mirror. But, nothing says we'll suddenly switch to value and dividends being strong winners. That is, winners tend to keep winning. So, perhaps it makes sense to consider some growth.
Here's a view into my own real world portfolio, where I've injected growth into the mix. Specifically, I bought into Starbucks (SBUX) in 2018, Disney (DIS) in 2016, Visa (V) in 2014. There are other examples but those are a pretty good representation for now. Here's how they've done since 2018 versus the S&P 500 (SPY).
At first glance, this might not seem "great" at all, because V and DIS have only done about as well as SPY. But when you inject SBUX into the equation, the overall capital gains greatly outpace SPY. It's about sizing and allocation, which is something I'll come back to soon.
In any event, step one is really quite simple. Continue to invest in value stocks and dividend growth stocks, but also decide on some comfortable allocation to growth stocks. This might be 5%, 10%, 20% or even higher. You can also start off with a very small allocation then scale up slowly.
Furthermore, you could consider allocating dividends to new growth stocks. After all, the best dividend growth companies will keep pumping out greater and greater dividends. So, you can enjoy those companies and your dividends while slowly building your growth stock portfolio, only using new money and without selling any of your lovely cash pumping machines.
For what it's worth, if you're buying value stocks right now, I like British American Tobacco (BTI), Lockheed Martin (LMT) and ViacomCBS (VIAC). I'm buying these companies but I'm also buying into several growth stocks. My point is that I'm not buying growth stocks to the exclusion of great bargains available in the market right now. You can have your cake and eat it too.
Step Two: Intelligent Allocation
This step is quite easy because I've previously outlined a rational and reasonable growth stock portfolio allocation methodology. It takes both risk and reward into consideration, as I spell out:
First, I think we have to distinguish between immediately setting up a full portfolio and buying stocks over time to build a portfolio. If you're a more conservative investor, then it's easier to consider something like 20 stocks and putting 5% into each stock. You could do that quickly and efficiently. In short order, you'd have a full portfolio, then you'd slowly and carefully manage from there, based on your investing goals, timeline and the like.
On the other hand, if you're setting up an aggressive or very aggressive portfolio, such as a growth stock portfolio, then your allocations are going to be far more messy, and the actual allocation percentages are likely to vary quite widely. Plus, it might take more time to build a growth stock portfolio since you'd likely need to wait for prices to come to you, versus wildly buying at any valuation - I strongly recommend against buying blindly like this in general, but especially with growth stocks. Valuation always matters.
There are three things I want to emphasize.
First, you're totally in control of how you set up your portfolio. You do it slowly, or quickly. You can allocate a lot of cash, or a little. You can buy a large number of stocks, or a few. You're the boss.
Second, diversification is still part of the plan. In fact, diversification is even more important when investing in growth stocks, if you're conservative. While it's true you might end up with the next Alphabet (GOOGL) or Amazon (AMZN), you might also be stuck with a Pets.com failure. Intelligent allocation gives you the peace of mind you strongly desire, via diversification and appropriate sizing. It's a simple as that.
Third, as I've indicated in the quote above, valuation always matters. Investing in growth stocks doesn't mean throwing caution to the wind, or completely ignoring fundamentals. It's really just understanding that the game is played differently.
Just a quick sidebar. Please read PayPal: The Star Business to better understand the Star Principle, which helps guide our decisions about business value. Also, read Palantir: The Rule Of 40 which provides an insight into valuable growth stock metrics. The point is that there are plenty of other ways to understand value, and some are better for growth stock investors.
In any event, the second step is that you can rationally allocate funds into growth stocks based on your own needs and goals. You can get started easily, and with lower stress, once you've decided to plan ahead just a bit.
Step Three: The Cautious Path Forward
It's possible you currently lack confidence in growth stocks, or your growth stock investing skill. That's perfectly understandable.
It's impossible to know if a great stock today, at seemingly nosebleed levels, will continue to outperform, or come crashing down. That's the fear; some stock you've bought goes to $0.00 and your future is destroyed. And, again, that's an understandable fear.
So, in addition to moving slowly, and using a wise portfolio allocation strategy, there's one more approach you can take to lower your risk over time. At a minimum, it's systematic and provides some peace of mind. If you haven't guessed, I'm specifically talking about dollar cost averaging.
As a caveat, in contrast to dollar cost averaging, Vanguard claims that immediate lump sum investing is prudent. Northwestern Mutual agrees:
The data show that investing a $1 million windfall all at once generated better cumulative total returns at the end of 10 years than dollar-cost averaging almost 75 percent of the time, regardless of asset allocation (a 100 percent fixed income portfolio outperformed dollar-cost averaging 90 percent of the time with a 60/40 at 80 percent, all equity at 75 percent). The disparity in performance held whether a portfolio was invested in all stocks or all bonds, and everything in between.
Nevertheless, while the empirical evidence is quite clear that lump sum investing is superior, it leaves out the psychological factor. Human beings are terrible at investing because they act irrationally at exactly the worst times. They chase stocks going higher due to greed and "FOMO" or fear of missing out. And, the sell out of stocks on dips and crashes, at exactly the wrong times, locking in permanent capital losses. Shudder.
Systematic, dollar cost averaging largely gets around this via a slow drip of investing discipline. And, when you combine dollar averaging with an intelligent portfolio allocation approach, you "slowly but surely" build up positions in great companies that are growing like crazy.
Again, I turn to Northwestern Mutual, since they largely agree that investors are irrational animals, but they add a critical point:
Dollar-cost averaging remains a solid strategy for consistently investing small amounts of money - like a portion from each paycheck going toward retirement. If you contribute to an employer-sponsored retirement plan, you are already dollar-cost averaging each time you're paid.
Dollar-cost averaging small amounts tends to be a better strategy than saving and accumulating cash and waiting for a "good" time to invest. Again, it's advantageous to be in markets sooner than it is to wait, because historical data show investors (even professional investors) aren't that good at timing markets. Dollar-cost averaging ensures a small amount of cash that's coming in the door is immediately invested in markets to capture potential long-term upside.
Lump sum investing produces superior returns but dollar cost averaging is more "human" and more practical. Keep dripping money into the winners as they keep winning. And, kill the losers when the businesses change course, start to slow down, or their stories are failing. Put another way, water the flowers and pull the weeds.
For example, I just recently wrote about CrowdStrike (CRWD). Here's how it plays out. First, establish a small position. Second, keep adding and watching. Third, if it wins by a lot (e.g., growth high, margins higher, etc.), enjoy the growth and consider adding more. But, if growth slows, or margins die off, or the story changes for some reason (e.g., leadership failure, insanely new and strong competition, government regulation, etc.), then consider selling - or, at least stop buying, and set the watch.
The "adding and watching" means you're dollar cost averaging, if you haven't already done your lump sum. Realistically, either approach can work, but that comes down to psychology. I prefer to consider the safe and conservative approach, but a more aggressive move isn't irrational if your conviction is high and your risk tolerance is also high.
Wrap-Up
Really, the three steps for setting up a growth stock portfolio are easy to understand and follow:
- Pick some amount that works based on your current portfolio, future cash flows, risk tolerance, goals, personality, and so forth. Make a conscious effort to define what amount of cash makes sense to invest, now and going forward.
- Use a portfolio allocation approach that compensates for your level of risk tolerance, due diligence, confidence, and such. Consider sizing in relation to what you know about yourself, and your ability to tolerate market volatility and also specific stock volatility.
- Set up a reasonable schedule for investing over time. Using the jargon, dollar cost averaging can be a good path forward. Set a schedule and stick to it, over time, adding to your portfolio of growth stocks.
If I really needed to condense this, I'd say: Systematically diversify into a set of growth stocks in line with your risk tolerance.
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This article was written by
Analyst’s Disclosure: I/we have a beneficial long position in the shares of BRK.B, BTI, VIAC, LMT, CRWD, DIS, GOOGL, AMZN, PYPL, PLTR either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
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Comments (20)
Precious metals especially silver are in the dirt. Imo great time to get in the pool
