Why You Need Growth Stocks In Your Portfolio

Through the end 2019, the stock markets have been on an unprecedented bull run. Now 10-years strong, investors have been enjoying significant market returns. Since the financial crisis, the TSX Index has averaged a 7.5% annual return.

This is the bare minimum that investors should have made and would reflect a well-balanced portfolio. There are ways however to create Alpha by focusing on certain stock classes. Stocks typically fit into one, or a combination of three buckets – income, growth and value.

This also translates to investor types.

A value investor is on the hunt for cheap stocks. They find stocks that are trading below their determined intrinsic value and purchase them expecting the stock to eventually recover to fair market value.

An income investors’ primary focus is to generate income from their investments. This can be via strictly high dividend paying stocks like Enbridge or Canadian Imperial Bank of Commerce. Or an investor can focus on dividend growth stocks to achieve compounding dividend returns, like Equitable Bank, who has raised their dividend for seven straight quarters.

Finally, growth investors are looking towards the future, willing to take on additional risk for outsized returns. Growth investors don’t mind paying a premium for a stock, because at one point due to accelerated earnings growth the market value for the stock will be much higher than it was when they purchased.

Growth investing has dominated overall return numbers

Historically, value and income investing have trumped growth. The tide however, has turned. Over the past decade growth investing has outpaced both value and income investing.

Research south of the border has shown that value investing (defined by a low price-to-book value) has produced an annual compound return of 12.9 per cent over the past decade.

In comparison, stocks with a higher valuation have outperformed by more 340 basis points (CAGR of 16.3%).

Likewise, the U.S. Dividend Aristocrat Index, one of the premier barometers for income investors has only averaged 11.63% annually.

Although this may not seem like much, it has a big impact. Case in point, let’s see what $10,000 invested in each of these scenarios would be worth today:

Growth @16.3% = $45,268.21

Value @12.9% = $33,646.46

Income @11.63% = $29, 966.91

Growth investing would have yielded 35% more capital gains than value investing and 51% more than income investing.

That is quite a significant difference.

The strange part, there are not many websites available to the retail investors that focus on growth. There are many that tout dividend and value investing, but growth is often overlooked.

Why?

It requires a higher risk profile.

And as we’ve seen lately, there can be periods of significantly volatility.

With a little patience however, the strategy can yield outsized returns. Especially if you combine growth and value. Our Growth screener over at Stocktrades Premium combines growth and value to rank the top growth stocks on the TSX.

Does it work? The proof is in the numbers.

Last year, the TSX Index posted its best year since the financial crisis.

Despite this, our Top 20 based on our growth and value methodology outperformed the TSX Index 87% of the time.

We know what you are thinking – the bull run can’t last forever.

While this is true, no one knows when the next bear market will happen. In the meantime, by investing in companies with a strong growth profile at respectable valuations, investors can limit their downside.

It is also important to note that we are in an unprecedented time for quantitative easing. The Feds are essentially printing cash at the first sign of any economic weakness. As fame investor Marin Zweig once said –  “Don’t fight the Fed”.

It is an in incredibly simplistic, yet effective approach to investing. When the rates are low, or the Feds are cutting rates, it is done with an eye to spur economic growth.

In turn, this propels the markets upwards. The evidence suggests, that our low rate environment won’t be coming to an end any time soon.

As such, there is a very good chance that growth stocks continue to outperform both value and income. If you’re looking for outsized returns, it may be wise to add a few to your portfolio today. 

Investors often neglect growth stocks due to their increased risk profile and the fact it takes a substantial amount of experience to pick winning stocks.

However, the best strategy for long term success is to combine growth, value and income to create a portfolio that can withstand any economic climate.

If growth stocks are missing from your portfolio, it has undoubtedly cost you significant amounts of capital over the last ten years. So, ask yourself, are you going to do anything about it moving forward in 2020?

Published March 02 2020