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When stock prices are soaring, it’s easy to pick winners.
I’ve been an active investor for over 20 years. With the exception of the period from 1995 to 2000, there has never been a better time to be invested in stocks.
During the last five years of this bull market, the S&P 500 index is up 102%. Only during the Internet gold rush of the 1990s has the S&P 500 done better. From 1995 to 2000, the index soared 200%.
The gains this year have propelled the U.S. stock market to all-time highs. The S&P 500 is up 23% in the first 10 months of the year. The last time the index did that well was back in 1997.
The returns in this bull market should bode well for every investor who has a considerable portion of their portfolio invested in stocks. Despite the stock market crash of 2008 and 2009, the S&P 500 is up 69% over the last decade. And it’s now 13% higher than its previous all-time high.
Select companies have done far better than these outstanding market gains. One group in particular is what I call go-go growth stocks.
There are always a few companies that capture the hearts of investors. These are often innovative companies that are transforming an industry and changing the world. I’m talking about companies like Cisco and Microsoft in the 1990s. And more recently companies like Apple, Amazon, and Facebook.
These companies can grow their sales and profits extremely quickly for many consecutive years. This rapid growth in turn attracts investors who are willing to pay a premium valuation for the growth opportunity. That can lead the valuations of stocks to disconnect from the fundamentals of the business. And that can be a dangerous situation for investors.
Despite my bullish outlook on the U.S. economy and the stock market, today I’m very concerned about the frothy market for go-go growth stocks.
It’s become relatively simple to pick winners in the last year. The recipe for success is this: buy shares of a rapidly growing company that trades at a premium valuation to the stock market. And wait for the stock to outperform the market by a factor of 2-to-1.
My past experience tells me to be cautious when investing becomes this easy.
The “greater fool theory” describes a time when prices are not driven by intrinsic values, but by the expectations of speculators.
I vividly recall this happening in the late 1990s with Internet stocks. And it’s happening again today with Internet stocks and other beloved go-go growth stocks.
In my real-money $100k Portfolio investment advisory, my subscribers and I have profited from the exuberance for growth stocks. Our position in Netflix (NASDAQ: NFLX) is up 374% in less than two years. Meanwhile our stake in Tesla Motors (NASDAQ: TSLA) has jump 279% in less than one year.
Recently, the valuation and fundamentals of these and other growth stocks have become disconnected. I’ve sold some shares along the way up to lock in profits. But I haven’t sold my entire stake, since I know that richly priced stocks can extend gains for years.
Today, investors don’t care much for valuations. But when they do, expect the biggest winners to quickly become the biggest losers. My advice is to keep a close eye on your portfolio and be ready to sell your overpriced stocks when the tides turn.