Who doesn't love a growth stock? By reputation, it beats the market in the long run, even if it gives you a heart attack along the way. It's the guiding star of conventional investment thinking: "For higher returns," the legend goes, "you have to take higher risks."
Investment adviser John Geewax of Geewax, Turker in Phoenixville, Pa., does not love growth stocks because, he says, the conventional wisdom is wrong. Higher risk does not necessarily produce higher returns.
Geewax has tracked 20 years of growth-stock performance (1966 to l985) on the New York Stock Exchange and concluded that:
The median growth stock fell behind the market averages by 0.77 percent a year. During this period, growth stocks were 18 percent riskier than stocks as a whole.
About 60 percent of all growth stocks underperform the average, giving you a better-than-even chance of picking a loser. More than one-half of the above-average returns are generated by 10 percent of the stocks.
The market punishes "high expectation" stocks more than it rewards them. In an unusually large percentage of cases, earnings come in much lower than expected. That causes the stock price to fall.
The more volatile a company's earnings, dividends and stock price, the less you're likely to earn on your investment, partly because you lose the power of compounding.
What is a growth stock? It's the sort of soaring company on which investors hope to make a killing. Its sales and earnings are growing fast; it reinvests earnings, paying low or no dividends; it sells in the marketplace for a consistently high earnings per share.
IBM and Polariod were pure growth stocks once, and everyone hopes to catch their like again.
In today's market, growth stocks include Genentech and Centocor in biotechnology; high-tech stocks like Micropolis, Seagate, Tandem and Prime; Waste Management, Browning-Ferris and Rollins Environmental; Wal-Mart, Dress Barn and Rose's Store's.
A company needn't be new to be a growth stock. Digital Equipment is in the growth category now, Geewax said. So is most of the drug industry -- stocks like Smith, Kline & Beckman, Bristol Meyers, Syntex and Squibb.
A few of the growth stocks will be big winners. On average they've been outperforming the market for the past eight months (although the consumer growth stocks gave up some gains in the last quarter). But Geewax's point is that an investment strategy focused on these kinds of companies won't excel in the long run.
The better investments, he says, are the so-called value stocks. They show rising earnings, pay rising dividends and sell for low price-earnings ratios. From l966 and l985, value stocks outperformed the market by 1.7 percent. Individually, about 55 percent of them beat the averages, giving you a better-than-even chance of picking a winner.
Value stocks are harder to find today because prices have run up so high. But some examples would be USX; the big banks; many chemical companies -- Dow, Allied, Union Carbide and Hercules; cyclical companies -- International Paper, Scott Paper, Mead Corp.; K mart and Sears Roebuck; Philip Morris, Norfolk & Southern and Salomon Brothers.
The hard lesson of growth stocks was learned long ago by the managers of so-called growth mutual funds. "Take a look at their portfolios," Geewax said. "Most of them aren't in growth stocks any more. They're simply invested in a run-of-the-mill selection of stocks."
To identify a true growth fund, Geewax offers this rough guideline, based on the current level of interest rates: The fund's yield would be about 30 percent less than the yield on Standard & Poor's 500 stocks (now 2.87 percent); and its price-earnings ratio would be 10 percent higher than the S&P (now at 20). Nor is it a growth fund if more than 30 percent of its portfolio is made up of stocks like Dow, IBM and USX.
By his lights, one of the few no-load (no sales charge) companies still selling pure growth mutual funds is the Twentieth Century group based in Kansas City: The Growth Fund (up 33 percent over the past 12 months, compared with 29 percent on the S&P 500); Select (up 24 percent); Ultra (up 22 percent); Vista (up 12 percent); and Giftrust (up 11 percent) -- all of them paying low or no dividends.
You might want to hold growth stocks or funds on speculation, to have some representation in that type of investment in your portfolio. But it's not a total investment strategy. If you were to follow only one strategy, Geewax said, it should absolutely be value stocks.