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Chapter 7. Grow, Baby, Grow!: The Growth Story

Chapter 7. Grow, Baby, Grow!: The Growth Story

Imelda's Growing Portfolio

Imelda was a conservative investor whose investment in the Vanguard 500 Index fund grew steadily from year to year, but she was jealous of Martha, her neighbor. Martha's portfolio doubled last year and Martha lorded it over Imelda. “Your portfolio is so boring,” she would say. “How do you expect to get rich with it?” Finally, Imelda asked Martha for some advice and Martha told her the secret of her success. She suggested that Imelda buy growth stocks. When Imelda protested that these stocks seemed highly priced, Martha told her not to worry. Earnings would grow next year and the high price-earnings ratio would help, not hurt. Finally convinced, Imelda invested her money in the biggest growth companies she could find.

Unfortunately for Imelda, the next year was an awful year for the market, with the market dropping 20%. Imelda's portfolio did much worse. Some of her companies did report higher earnings, but not enough to keep markets happy, and their stock prices tumbled. Other companies went from making money to losing money, as the economy slowed. Imelda lost more than half her portfolio and her only consolation was that Martha did even worse. Chastened, Imelda sold her growth stocks and put her money back into the index fund.

Moral: Growth often comes with a hefty price tag.


Growth stocks are exciting, and investors who seek to make extraordinary returns are drawn to them for that reason. If you succeed at picking the right growth companies to buy, your payoffs can be huge. An investor who bought Microsoft and Cisco when they were small growth companies would have seen her investment grow 50-fold over a decade. Does it follow then that a strategy of investing in stocks with high growth rates will deliver high returns? As you will see in this chapter, succeeding at growth investing is very difficult to do for several reasons. The first is that growth can often be a mirage, since very few growth companies consistently deliver growth. The second is that not all growth is created equal; while some growth is value creating, some growth is value destroying. Finally, even the most attractive growth in the world may not be worth it if you pay too much for it.


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