Are You a Growth or Value Stock Investor?

I was at a cocktail party recently, and a friend who’s a hotel manager asked what stocks I was recommending now.

In return, I asked, “What kind do you want—big and undervalued, that will appreciate in the long term, or smaller and faster-growing, that are likely to bring you more action, and more risk, now?” Translation: do you want value stocks or growth stocks?

He chose the former, bigger and slower with low risk, so I suggested General Motors (GM) and Target (TGT).

General Motors (GM)

General Motors (GM) now pays a dividend of 4.8%, which is an awesome yield in today’s environment. Plus the stock trades at a P/E of 6, which is pretty cheap.

As for the chart, GM has been advancing in synch with the broad market since mid-February, and just last Thursday hit its highest point of the year.

Target (TGT)

Target (TGT) now yields 2.7% (not too shabby) and trades at a P/E of 18, which seems fair considering that earnings are projected to grow 12% next year.

Here’s a chart.

However, both GM and TGT are near the top of their recent trading ranges, which means there’s a good chance for a short-term correction from both—and I don’t like to buy stocks when the odds favor a short-term correction. Instead, I like to buy stocks that are primed to move higher in the short term as well as the long term.

What stocks are those, and how do you find them?

To find the short-term move candidates, I look for stocks that have built strong short-term launching pads. Take a look at Sprouts Farmer’s Market (SFM), for example, a company that I like to call a junior Whole Foods Market (WFM).

Sprouts’ products are cheaper, and the company has great growth potential, too! The stock was recommended by Mike Cintolo in Cabot Top Ten Trader about a month ago, and he’s been updating his readers on its progress every week, as this setup progresses (so far) in textbook fashion.

To find the candidates for long-term advances, however, I look for stocks that most people don’t like, or are not even aware of!!!

You see, while it’s prudent and relatively low risk to invest in stocks like General Motors and Target, any stock that is already as widely known as those two is unlikely to have great appreciation potential.

Which isn’t to say that the potential doesn’t exist—it certainly does.

But the fact is that any big-name stock is well known to all Wall Street analysts as well. And since there’s no chance you can get information on those stocks that’s any better than theirs, when you invest in those stocks, you’re betting against some of Wall Street’s best.

On the other hand, when you can identify a growth stock before it’s well known, and before most investors are aware of it, you can take advantage of the fact that when they do discover it, their buying can boost the price higher, and increase your profits!

Back at the cocktail party, I suggested the names General Motors and Target partly because they suited my audience; the questioner wanted a slow and safe investment, and most people feel more comfortable buying a name they know rather than a name they don’t know.

At the same cocktail party, however, I met a brilliant but self-absorbed fellow who works in the commercial publishing industry, directing scores of people in India who convert paper publications into digital formats in a variety of languages. He spouted statistics about global sales of blockbusters like Fifty Shades of Gray and Howard Stern’s Private Parts, and—most relevantly—he claimed that he knew from the start that Amazon (AMZN) would be a great success.

Well, I was too polite to disagree, but I’m highly skeptical of anyone—especially someone in the publishing industry—who claims they knew from the start that Amazon would be a big success. In fact, I remember quite clearly that in its early days, industry experts in particular were predicting that Amazon would be crushed by industry giants Barnes & Noble (BKS) and Borders Books (RIP!).

(For the record, AMZN came public in May of 1997. Cabot Growth Investor recommended the growth stock in January 1998, when the company was losing money but the stock was valued at 14 times its annual revenue. And by the time we recommended selling it in January 2000—both the stock and the market were rolling over—our profit was 1,290%!)

More recently, a similar trajectory was traced out by my recommendation of Tesla Motors (TSLA). My readers bought in December 2011, before the Model S was even launched, when the company was losing money hand over fist, and those who are still holding it are looking at profits of more than 700%.

The similarities, in both cases, are that both growth stocks were quite strong when recommended, both companies were losing money, and both companies were viewed skeptically by the majority of investors.

But as that skepticism slowly grew to grudging acceptance and then appreciation and then optimism, the buying of the masses who were changing their opinions lifted the stocks higher!

This psychological component to investing is one I think most fundamental analysts don’t appreciate, and I think if you can combine that with a hunt for growth stocks that Wall Street doesn’t know about yet, you can rack up some pretty spectacular returns!

So, with that background, here’s today’s suggestion.

TAL Education (XRS)

TAL Education (XRS) is one of the largest private educators in China, offering a variety of services for students from pre-school through high school. Using three formats—small classes, personalized tutoring and online courses—it teaches core topics like math, English, Chinese, physics, chemistry and biology.

Unlike Amazon and Tesla, TAL Education is profitable now, and growing at a good clip; revenues were up 38% in 2015, while earnings were up 22%. This year, earnings are expected to grow 27% (the first-quarter report is due Thursday, April 28).

And, of course, very few investors in the U.S. have ever heard of the company. Thus, at the least, I think the company will do well as it grows, and the stock will do well, too. But just imagine what might happen as more and more U.S. investors become aware of the company and slowly upgrade their opinion of Chinese education? And, thinking creatively, what might happen if the company enters the U.S. market, to begin competing in our overpriced, underperforming elementary and high school systems?

I can’t predict what’s going to happen, but it’s pretty clear from watching the chart that investors’ perceptions are already improving.

And, as I’ve said many times, trends tend to go further and last longer than most people expect.

So, you could take a flyer and jump on XRS right now (just be careful to use the proper symbol, not TAL). But a better idea would be to become a regular reader of Paul Goodwin’s Cabot Emerging Markets Investor. Paul recommended XRS to his readers back in December, just as it broke out from its long base at 39, and those readers are now sitting on solid profits, while expecting the stock to climb much higher. For a limited time, you can try out the advisory at 50% off.

Sincerely, 

Timothy Lutts
Chief Analyst of Cabot Stock of the Month 

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