exiting a growth stock

To paraphrase/summarize my last few posts, the key to value stock investing is to buy when things couldn’t be worse.  For growth stock investing it’s to leave the party when things couldn’t seem better.

Generally speaking, the key to making a successful exit from a growth stock is to always keep in mind the qualitative “elevator speech” whose essence is that it contains what you think gives the firm a special edge.  When that story begins to erode–maybe new competition emerges, or the target market the firm is exploiting gives signs of being saturated, or tastes change–it’s time to edge toward the door.  The important thing to remember is that this erosion occurs long before earnings growth begins to slow.

The first disappointing earnings report is typically followed by continuing bad news, so it’s not to late to get out then.  But that first bad report is typically a long way from the top for the stock.  The leading indicators are what really count.  They differ from stock to stock.

Take Wal-Mart as an example.  Its main business was opening superstores in small towns.  Government statistics could have told us how many such towns there are in the US.  That data allow us to figure out how many years of growth the company has before it’s forced to do something different.

Deviations from the norm are another indicator. Starting a second brand suggests #1 may be getting a bit long in the tooth.  Opening outlets in notoriously difficult markets like Los Angeles or New York might also be a signal.

A PE that’s too high for the firm to ever grow into is a third signal that things can’t get much better for the stock.

 

One caveat, something that makes the situation trickier:  most growth companies are unable to reinvent themselves when their initial good idea runs out.  The best of the best, however, are able to do so.  Some of them can do this multiple times.

Apple, for example, has had several lives.  It was initially the story of a near bankrupt company coming back from the brink (led, ironically by the man who put the enterprise on the road to the precipice in the first place, Steve Jobs).  Then it was the iPod company.  Then it was the iPhone company.   Most recently, it’s the firm Tim Cook saved from the craziness of having a phone that’s too small and a tablet that’s too big.

These situations are rare, however.  And there’s always time to change your mind after reducing a position or eliminating it entirely.  So the possibility that stock X might be another AAPL isn’t enough, io my mind, not to exit once the qualitative story begins to break down.

One response

  1. Pingback: What stocks to invest in = exiting a growth stock « PRACTICAL STOCK INVESTING | Stock Investing

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