Growth Shares

Pay Heed to Growth Shares:

There are many fundamental analysts who believe that investors would do well if they focus on growth stocks. Their investment philosophy consists of three basic guidelines: (1) Develop sound standards for selecting growth stocks. (2) Invest in growth stocks, without much concern for the price. (3) Hold growth stocks, as long as they remain growth stocks. Without being unduly bothered about timing, growth stock advocates argue that if the right growth stocks are bought and held as long as they remain growth stocks, superior returns are earned. As one growth stock proponent put it:
The price of a growth stock always seems high. But don’t worry. Buying it and putting it away assures an eventual profit as earnings growth devours whatever price premium you may have thought was present. The trick is to select good quality growth stock and have patience. The uncertainties of the market, the economy, politics, and international development may have a short term impact on the price of your growth stock, but over the long run growth in earnings will pull you through.

What criteria are relevant for selecting growth stocks? Fifteen distinct points are noted to identify growth stocks. The major points suggested are: (1) products and services with significant potential for increase in sales; (2) managerial determination to develop new products to substitute the present products when they reach maturity; (3) substantial profit margin; (4) good labor relations; (5) effective cost controls; (6) competitive strength (7) integrity and (8) depth of management. While different growth stock advocates may suggest different criteria, the essence of these criteria would be substantially the same.

Though one may subscribe to the growth stock philosophy, it may not be prudent paying a very high price earnings multiple for a growth stock. If it commands a very high price earnings multiple, it means that the anticipated high growth is already discounted in the price. Such a stock is highly vulnerable to a decline in earnings. If that happens, the price tends to drop sharply as the multiple declines along with earnings. A recommended strategy is to identify growth situations which have not been fully discounted by the market. If the growth actually takes place, you will benefit doubly. Along with the increase in earnings the price earnings multiple would also rise, generating large gains.

Ideally, the stock market is supposed to be highly competitive and efficient, where no single participant (or group of participants) can significantly influences prices. In practice, however, the stock market in India suffers from imperfections and inadequacies that permit operators to play certain games that can be detrimental to the unwary and unguarded; though of course the smart investors can profit from them.

As an investor, beware of the manipulation done to artificially push up share prices and create conditions for disposing of a large block at inflated prices. The operation often involves the following steps:

1. The manipulator activates the target share by resorting to scattered buying in a disguised manner through a few brokers simultaneously
2. As the price moves up in response to this buying, newsletters, brokers and financial magazines are persuaded to recommend the share to the investing public, sometimes with very specific claims that the price will double in three to six months.
3. As investors are drawn into the game, the upward price movement is maintained with some further support from the manipulator. As a result, the claims of doubling or so are fulfilled. This in turn attracts the interest of more and more investors which tends to further fuel the price rise.
4. When the share becomes very buoyant and the volume of trading increases sufficiently, the manipulator begins to offload his bulk holding. This is usually done in installments, taking into account the absorptive capacity of the market. Sometimes, the manipulator may even resort to short selling when the price is buoyant because he knows that the investor demand would eventually fall off, leading to price declines when he can profitably square off his short sales.

If his strategy works well, the manipulator gains in two ways: (1) he liquidates his large holdings during the buoyant phase; and (2) he covers his short sales in a declining market. Along with the manipulator, the early entrants benefit provided they book their profits at the right time. Finally the brokers gain in the form of large trading commissions. The real losers are the late buyers who are lured into this game when the prices are near their peak level.