Because the best growth stocks often outpace the market and can generate double- or triple-digit returns far faster than more conservative investments, investors often ask us how to invest in growth stocks.
Before we get into more details on the methods we use, there is a caveat. When you’re investing in growth stocks, you’re generally targeting companies that are less mature, have smaller margins, and typically don’t pay a dividend.
Thus, the stocks can be very volatile, especially around earnings season. For many investors, however, the risks of investing in these stocks are worth the potential rewards.
The following rules have been carefully selected as the most important set of guidelines an investor can use when investing in growth stocks. These rules form the foundation of growth investing and the investment philosophy used in Cabot Growth Investor, our flagship publication, in which they have been applied and refined since 1970.
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10 Growth Investing Rules
1. Invest in Fast-Growing Companies
You’ll usually find them in today’s fast-growing industries, where revolutionary new technologies and services are being created. As you study the stocks in these growth industries, you should favor lesser-known stocks that have yet to reach the point of peak perception. Frequently these will be smaller stocks, where growth potential is greater!
2. Buy Stocks with Strong RP Lines
Relative performance (RP) studies are a superb way to identify strong stocks and to avoid underperformers. You should buy stocks that are consistently outperforming the market. This is a good indication that they are under accumulation, week after week, month after month, and that the companies are attracting investor interest and institutional dollars. The best growth investing tips come from the performance of the stocks themselves. So ignore hot tips!
3. Use Market Timing to Guide Your Growth Investing
Be cautious when the broad market is against you and aggressive when it’s with you. Don’t underestimate the power of the market to move stocks, both up and down. When Cabot’s market timing indicators are signaling a bull market, don’t delay. When the trend is up, stocks will be going up! Buy your favorite stocks and hang on as long as the ride is profitable.
4. Once You’ve Invested in a Stock, Be Patient
Recognize that time is your friend in growth investing. Frequently stocks don’t go up as fast as you might want them to. But if you can develop a persistent and tolerant attitude coupled with plenty of patience, you’ll have a great advantage. We call this STAYING POWER! (The need for patience does not apply to losses. Read Rule 6.)
5. Diversify Your Portfolio
For our Model Portfolio, 10 stocks provide plenty of diversification. Smaller investors can do well with as few as five stocks, but you should never have all your eggs in one basket when growth investing.
6. Cut Losses Short
This is the key to ensuring that you retain enough capital to stay in the game. No matter how hard you try, you are going to select stocks that go against you as soon as you buy them. Get rid of these stocks quickly! Never let your loss exceed 20% of your original investment, based on the closing price of the stock. This is a most important rule, and yet we repeatedly hear from investors who ignore it, hold on and suffer far greater losses. They learn the value of this rule the hard way.
7. Sell a Winning Stock When it Loses its Positive Momentum
This is a clear indication that other investors are selling too. And a lot of them know more than you do. So don’t wait for the company to tell you about the bad news. Sell first and read the bad news later. You can usually tolerate RP line corrections of as long as eight weeks but seldom more than 13 weeks before concluding that the stock’s momentum has turned negative. When these limits are exceeded, sell the stock without regret.
8. Let Your Profits Run
The power of compound growth can swell your account dramatically—if you are patient. Long-term investments make more money than short-term investments. So learn to develop staying power. Let your profits run and run and run. This is how big money is made in the market. Not by taking 10% and 20% profits but by thinking big—in terms of 100%, 200% and larger profits.
9. As Time Passes, Buy More Shares of Your Best-Performing Stocks
Add a modest number of shares to your winners from time to time, trying to do this during corrections in the stock, not after the stock has posted a major run-up. Called “averaging up,” this is a great way to reinforce your investments in your best stocks.
10. Be An Optimist
In our five-plus decades of publishing the Cabot Growth Investor, we’ve seen many ups and downs for both the market and our country. But after every tough event, our dynamic country and economy have eventually rebounded. So no matter how bleak the situation, always stay optimistic because our country and stock market will give you some dazzling growth investing opportunities!
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*This post is periodically updated to reflect market conditions.
