Every investor dreams of how he could have bought Amazon during the dot com bust or buying Apple at the iPhone launch or buying Microsoft during the 90s and ending up with millions of dollars. The stocks are inconspicuous at the beginning years for an extended streak of time but once they become the darlings of Wall street, there is no looking back.
Dreams aside, is there any way to identify these opportunities and grab them? To hold on to them is a topic for another post but the first step of identifying them requires attention. Is there any characteristic to identify?
In every time period, there is a sector which is the favorite for all the investors. Technology is the favorite right now. There was a bitcoin boom recently. Dot com sector was before that. But it’s also important to know that there will be lots of entrants in that sector and each will be treated like the next big stock. These companies usually incur losses (negative earnings) and even if they have earnings, the P/E multiples will be through the roof.
When should one buy growth stocks?
Let me first answer when not to buy the growth stocks. It is during their IPO or at least 2 years after their IPO.
The best time to buy the growth stocks is during a major market correction. Let all the euphoria and hype come crashing down and while the dust is settling, start looking around for real gems that have collapsed undeservedly.
I outline the following characteristics to identify a potential growth stock:
- There is an exploding revenue growth of 100% or more each year.
- This company is penetrating into the common folks everyday life.
- An existing giant in the sector is being disrupted by this company.
- The price of the stock is not more than 10 times the cash from operations. If it’s greater than that, you may already have missed the boat. Wait for any market correction.
- The stock is trading at the most at 2 times the revenue.
- The company has carved a new market and is the first mover.
- The business model has less capital expenditures. There is a franchise model in place that lets the company grow without needing a lot of capital.
- The management is not rewarding itself with huge stock options rather working to increase the shareholder value.
Risks involved
It should be understood outright that there is a great risk involved in investing in high flying stocks. These may either be momentum stocks or real growth stocks. Do not jump with both feet but rather invest over a period of time and be disciplined about your portfolio allocation.
Conclusion
Identifying a growth stock is not a quantitative undertaking rather qualitative which is very difficult to nail. Stick to your circle of competence, do not take huge risks and be patient, your portfolio will definitely be rewarded if you do.