Hot Stocks, Cool Prices

As the market surges, here's how to invest in growth stocks without overpaying

Growth is good. And the earnings numbers on Wall Street look strong. In the first quarter of this year, the median company in the Standard & Poor’s 500 stock index posted year-over-year earnings growth of 10.1%–marking the 19th straight quarter of double-digit growth, according to Zacks Investment Research. And with the Dow Jones industrial average up 22.5% since January of last year, investors may be scratching their heads when trying to find untapped investment opportunities.

These are market conditions that take Randy Philip, who heads a health insurance agency in Alexandria, Virginia, back to the tech boom of the late ’90s. Like so many investors, when the market was peaking, Philip, 40, failed to capture the paper profits of his tech investments. Ultimately, he came to recognize that he didn’t have the time to do the necessary homework, so he’s out of the stock picking game. Instead, he invests through mutual funds.

Philip recently added a mutual fund to his portfolio and he’s glad he did: “My new fund, T. Rowe Price Growth Stock (PRGFX), has a strategy I like: It buys good stocks at depressed prices.” Philip has followed this strategy himself. Several years ago, he invested in cruise line operator Carnival Corp. (CCL), after its stock fell from more than $50 to $24 a share. Now back up to $50, the shares are still in Philip’s portfolio, but he’s not looking to make any more bets on individual companies. The Growth Stock fund accounts for about 10% of his portfolio, and Philip now seeks the investment advice of Dywane Hall, a principal in the Alexandria office of LPL Financial Services. “Our goal is to bring him up to a 25% allocation in funds following this discipline, in order to maintain our growth allocations yet reduce our risk in the event that the markets turn down,” says Hall.

The discipline that Hall refers to is known as growth at a reasonable price, or GARP. It’s a style that’s a blend of both growth and value investing. That is, GARP investors buy growth stocks–companies expected to post above-average increases in sales and profits. At the same time these investors take a value-stock approach, looking for situations where the share price is low, relative to earnings and cash flow.

“You can divide growth stock funds into three categories,” says Karen Dolan, a mutual fund analyst at research firm Morningstar in Chicago. “There are classic growth funds, which look for good stories, indicating a company will have above-average earnings growth. There are aggressive growth funds, which may have a momentum strategy–they like stocks that have performed well recently. GARP funds, in the third category, might be considered the most conservative of growth funds because although they pay attention to growth, valuation is an important consideration as well.”

Measuring Growth
To start, GARP investors look for some minimum level of growth, such as an expected annual increase in earnings per share of 10% or better. They also look at valuation measures such as the price-to-earnings (P/E) ratio. A

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