10 Reasons Why Growth Stocks Can Be Appropriate For Retired Investors by Chuck Carnevale, F.A.S.T. Graphs
In recent weeks I received several questions and comments from readers regarding my views on the appropriateness of investing in growth stocks in retirement portfolios. Additionally, and on a related topic, I have also come across numerous discussions, sometimes quite heated, about whether it’s best to invest for total return or growth of dividend income. Consequently, I thought it would be interesting to share my views and provide my perspectives on both the appropriateness of growth stocks, and/or whether it’s best to invest for total return or income growth.
Generally speaking, I do not believe there is a perfectly correct answer to whether growth stocks are appropriate in retirement portfolios or not. Instead, I believe that it depends on many factors that specifically relate to each individual investor’s unique situation. More specifically, these include their financial resources, investing goals and objectives, and perhaps most importantly, their tolerance for risk. With this article I will offer 10 reasons or situations where I believe growth stock investing might be appropriate in retirement portfolios under certain circumstances.
Jim O’Shaughnessy: Fear Signals Created By The Reptilian Brain
ValueWalk's Raul Panganiban interviews Jim O’Shaughnessy, Chairman, Co-chief Investment Officer, and Portfolio Manager at O’Shaughnessy Asset Management. In this part, Jim discusses the fear and emotional signals created by the reptilian brain. Q1 2020 hedge fund letters, conferences and more That's very cool. For the factor to try to seek the reason why it works, Read More
In the same vein, I also do not believe there is a perfectly correct answer to whether it’s best to invest for total return or income growth. However, here I will add that I do not believe that the two concepts, total return versus income, are mutually exclusive. Under the correct circumstances, prudent and rational investing practices can generate both simultaneously. I do not believe that you have to give up attractive total returns for income, and vice versa. But regardless, I see no reason to argue about it, and believe in affording each investor the freedom and right to follow his or her own personal and/or suitable path.
Finally, I am a fervent believer that investors should be knowledgeable and aware of all the investment options at their disposal. In other words, I do not favor a myopic approach nor do I favor being overly zealous about one investing strategy over another. Instead, I believe all investing strategies should be fairly and knowledgeably evaluated so that they can be clearly understood. Once that is accomplished, then rational decisions can be made regarding whether or not a certain strategy is right for you.
10 Conditions or Circumstances When Growth Stocks Might Fit in Your Retirement Portfolios
Before I provide the 10 circumstances where I believe growth stocks might be appropriate in retirement accounts, I feel it’s only fair to point out that I have long admired the power, performance and even protection that a great growth stock can offer investors. Consequently, much of what I’m about to write is colored by my own biases and perspectives. In this regard, I am only sharing my own views and will let the reader draw their own conclusions. However, not all of what I’m about to present is bias. Much of what I will be talking about is based on factual analysis, and as such, I would hope the reader takes that into consideration as they review the following 10 reasons.
1. Performance Considerations-Opportunity for Significantly Higher Total Returns
There is one undeniable fact about true growth stocks that is nevertheless hotly debated and argued about. In truth and fact, a pure unadulterated growth stock under the strictest definition is capable of dramatically outperforming most blue-chip dividend paying stocks. And as I will soon demonstrate, the total return differences are not subtle, they are significant and profound. However, I contend it is also an undeniable fact that the risk differential between true growth stocks and blue-chip dividend paying stocks is equally as significant and profound.
In order to illustrate my point, I offer the following performance histories on 3 high profile growth stocks compared to the average company represented by the S&P 500 over the past 10 years or so. There are a couple of reasons why I specifically chose the timeframe covered. First of all, each of the example companies and the S&P 500 were all fairly valued at the beginning of this time period. Therefore, their performances are all being calculated fairly.
Second, I chose this timeframe because a decade of time is adequate to illustrate a long-term performance calculation. Finally, I chose this timeframe because it included the Great Recession, which I hope we would all agree was a very challenging time to be investing in equities.
The following performance calculations are based on a single $10,000 investment in each company at the beginning of the time period. None of these examples pay a dividend, but in spite of that fact, they each produced total returns that were orders of magnitude greater than the S&P 500. As an aside, commonly held blue-chip dividend growth stocks such as Johnson & Johnson, Coca-Cola, Procter & Gamble and General Mills all produced total return performance results that were within the same scope as the S&P 500.
I have also included the 12-year historical earnings price and correlated FAST Graph on each example. I have circled the earnings growth rates on each graph to illustrate how a growth company’s historical earnings growth rate correlates and relates to the performance it generates for shareholders.
To get a free, more detailed perspective on Growth Stocks, follow this direct link to a video on my site mistervaluation.com, and watch and listen to me analyze Growth Stocks out loud via the F.A.S.T. Graphs™ fundamentals analyzer software tool.
Celgene Corporation (CELG)
Baidu Inc (BIDU)
Company description, courtesy of Seeking Alpha:
“Baidu Inc is a Chinese language Internet search provider. The Company offers a Chinese-language search platform on its website Baidu.com.”
Company description, courtesy of Seeking Alpha:
“Actavis PLC specialty pharmaceutical company engaged in developing, manufacturing and distributing generic, brand and biosimilar products.”
As investors, we can never invest in the past, only the future. Therefore, I offer the following F.A.S.T. Graphs™ Forecasting Calculators on each of the three examples above to illustrate their potential total return performance over the next couple of years based on consensus analyst estimates. For the reader’s additional perspective, I also include the same Forecast Calculators for the blue-chip Johnson & Johnson (JNJ) and one for the S&P 500.
The bottom line based on reason number 1, is that investors in retirement should at least be aware of the differentials of potential returns that true growth stocks can offer. However, I would caution that due to their higher risk, growth stocks should be utilized judiciously and sparingly. But that is not to say that they should never be included in retirement portfolios.
2. Today’s Growth Stock Can Become Tomorrow’s Dividend Growth Stock
The second reason or situation when growth stocks might be appropriate in retirement accounts is that they often provide the opportunity to generate future income without being forced to sell off shares. This is a primary argument against growth stock investing that is often presented. Many investors further believe that you would eventually have to liquidate your non-dividend paying growth stocks and convert them into income-producing stocks when you reach retirement. In truth, this may actually not be necessary. Over time, and it can even be said eventually, the growth rate of a growth stock will slow down, and quite often the company can change from a growth stock to a dividend growth stock. There are a lot of technology stocks where this metamorphosis is occurring today.
Eventually, and as a general rule, the true growth stock will ultimately morph into, first a moderate grower, then typically into a moderate growth and income grower by instituting a dividend, and eventually into the slower growth and dividend income stock.
My point is that an original pure growth strategy started early in your life, could in fact, naturally evolve into an income-producing portfolio when you reached the time where you needed to harvest income (retirement). The following earnings and price correlated F.A.S.T. Graphs™ and associated performance results on Apple clearly illustrate this point.
Apple Inc (AAPL)
First of all, a careful analysis of the earnings and price correlated graph with dividends on Apple shows that its growth rate in recent years has begun to slow (see highlight at bottom of graph). Additionally, we see that Apple instituted a dividend in 2012 that has increased every year since it was initiated. In other words, this once pure unadulterated high-growth stock has in recent times morphed into an above-average growing dividend growth investment.
The associated performance report with the above graph tells a couple of interesting stories. First and foremost, we see a long-term total return performance result that is nothing short of extraordinary. The comparison against the average company as measured by the S&P 500 speaks for itself.
However, what might be more interesting is the fact that even though Apple has only been paying a dividend since 2012, this once pure growth stock has generated significantly more cumulative income than the S&P 500 on a $10,000 investment since 2004. Apple shareholders earned $16,392 dollars of cumulative dividends versus only $2,547 in the index.
Looking to the future, we see the consensus estimates for future growth are significantly below what we saw in the historical graph above. However, Apple the dividend growth stock is currently fairly valued and consensus expects future earnings growth to exceed 17% per annum. Clearly, adding Apple to a retirement portfolio approximately a decade ago would have produced potentially life-changing results, and better yet, the party is far from over. This blue-chip AA+ rated technology stalwart still possesses the opportunity to generate above-average future returns with the added bonus of the opportunity for high future dividend growth.
3. You Already Have All the Current Income You Need
A third reason when it might be appropriate to include growth stocks into a retirement portfolio would be when the retiree’s portfolio already generates all the income they need to support themselves and their families. With their future income needs secured, perhaps by a portfolio of blue-chip dividend paying stalwarts, it might make sense to add a little growth to the portfolio.
Even though the relative risk may be a lot higher, adding a few growth stocks might be the ticket to fund some future unnecessary luxuries. Perhaps a boat or the sports car you dreamed about owning someday, or maybe traveling to exotic locations. Since your basic needs are already covered by your conservative investments, it might make sense to add a little risk and growth to your retirement portfolio.
4. Time and Inclination
The fourth reason when growth stocks might be appropriate to add to your retirement portfolio is when the investor has the time and inclination to apply the necessary work and effort that owning growth stocks requires. To a great extent, investing in blue-chip dividend growth stocks such as Johnson & Johnson are analogous to the theme of the old Ronco commercial. You can “set them and forget them.” High-quality blue-chip dividend paying stalwarts do not require as much scrutiny and due diligence as growth stocks do.
In contrast, high-growth stocks are much more research, due diligence and continuous monitoring intensive. High-growth is rare, and very difficult to achieve. Consequently, when investing in growth stocks I suggest you be prepared to put in the necessary work and effort to keep up with the company, its industry and the competition. In a free market, competitors won’t let a high-growth company keep the market to itself. If the investor is not willing to put in that effort, then growth stocks may not be appropriate in their retirement portfolios.
5. Growth Stocks Are Contemporary, Interesting, Exciting and Even Fun
Especially if you meet condition number 3 above, adding some growth stocks to your retirement portfolio can be stimulating and even fun. To paraphrase another popular commercial, growth stocks are not your grandfather’s blue-chip dividend paying stalwarts. Many of the best growth stocks operate in exciting industries that can be stimulating, interesting, exciting and, yes, even fun to evaluate.
However, the following earnings and price correlated graph on Gopro, Inc illustrates that fun and excitement can also be scary. The short performance history of this growth stock has been extremely strong. On the other hand, its price action has also been a titillating rollercoaster ride. Had you bought this stock on its IPO, you would have come close to doubling your money in approximately 3 months time, only to see the stock price fall to below your original cost basis before rising again to a profitable position. Growth stock investing is not for the timid or weak of heart.
GoPro Inc (GPRO)
Company description, courtesy of Seeking Alpha:
“GoPro Inc develops hardware and software solutions to alleviate consumer pain points associated with capturing, managing, sharing and enjoying engaging content. It produces mountable and wearable cameras and accessories.”
6. Growth Can Overcome Valuation Mistakes
Although I would acknowledge that investing in high-growth stocks is undoubtedly riskier than investing in blue-chip dividend growth stocks, their rapid growth can effectively mitigate some of the risk. Thanks to the power of compounding (see reason number 8 below) the company that is growing its earnings very fast can bail investors out even if they overpay for the stock at purchase. Of course, this assumes that the company continues growing at above-average rates. And more importantly, assumes that the investor stays the course, which admittedly is an aggressive assumption.
The following earnings and price correlated graph on Starbucks represents a case in point. Had you invested in the company at its peak P/E ratio of 53.6 on June 30, 2006 you would have obviously suffered significant losses over the next 3 full years. However, considering that this original irrational behavior took you into the throes of the Great Recession, and further considering that the company remained profitable you would have made money long-term. Above-average earnings growth bailed you out in spite of the fact that the current P/E ratio of 34.7 is significantly below the P/E ratio you paid at original purchase.
Starbucks Corporation (SBUX)
7. Growth Stocks Are Often Misunderstood
My definition of a growth stock is straightforward and precise. First of all, a growth stock represents the common stock of a company whose business is consistently growing earnings and cash flow at a significantly above-average rate. In other words, a growth stock is a company whose earnings are consistently increasing at a minimum rate of change of earnings growth of 15% or better. However, a hyper growth stock is one that I define as growing earnings at a rate of change of 25% or better. Admittedly, although both categories are rare, there are more 15% growers than there are companies growing earnings at 25% or higher. In between these broader gradations of growth are additional growth categories such as a high grower at 20%, etc.
The reason I bring this up in reason number 6, is because my experience has taught me that modern finance often holds a very cavalier or vague definition of what a growth stock is. Consequently, those engaged in the growth stock versus dividend growth stock debate will often cite studies indicating that dividend stocks outperform growth stocks. However, when I have personally reviewed and analyzed many of those studies, I usually discovered that the researchers were taking great liberties with the definition of a growth stock.
Consequently, many investors hold a jaundiced view of growth stocks that in my opinion is not fairly applied. In the context of this article, I am only discussing the possibility of adding true growth stocks into retirement portfolios based on the definition of a growth stock provided above.
8. The Power of Compounding
Although my reason number 8 is closely aligned with my reason number 1, I offer it as an additional reason looked at from the perspective of time compression instead of total rate of return generation. Thanks to the power of compounding, investing in growth stocks can in effect compress time. In other words, instead of taking a decade or more to double your money in a blue-chip dividend growth stock, you can double your money much quicker in a true growth stock.
To illustrate my point I will turn to the widely recognized Rule of 72. This rule states that you can calculate the number of years it takes to double your money at a given compound return by dividing it into the number 72. I have often utilized the following illustration to illustrate the point I am making about the power of compounding compressing time.
First I will make the assumption that the average person has a working lifespan of 36 years. In modern times this may be a conservative assumption, but as I will soon illustrate it facilitates the math. Next I will assume two different compound rates of return as they apply to the average dividend growth stock, and then to the pure growth stock. For the dividend growth stock I will assume a generous and above- average rate of return of 10% per annum. For the pure growth stock I will assume the appropriately higher rate of return of 20% per annum. The math then looks like this:
With the dividend growth stock, If I divide 10% into 72 I calculate that it will take 7.2 years to double my money (72/10% = 7.2 years).
With the pure growth stock, if I divide 20% into 72 I calculate it will take 3.6 years to double my money (72/20%=3.6 years).
If I apply this math to my assumed average working life of 36 years I get the following results:
If my money doubles every 7.2 years at a 10% rate of return, I will get 5 doubles in 36 years (36/7.2=5).
If my money doubles every 3.6 years at a 20% rate of return, I will get 10 doubles in 36 years (36/3.6=10).
The net effect is that by doubling my average rate of return from 10% to 20% per annum I do not earn two times the money by earning twice the return. Instead, I get double the doubles. Looked at from the perspective of the first $1 (dollar) invested the power of compounding (compressing time) becomes vividly clear. Doubling my first $1 (dollar) 5 times at the 10% return results in the following: $1 doubles 5 times to $2, $4, $8, $16, and finally to $32. However, at the 20% return I get 5 additional doubles over the same 36 year timeframe as follows: $64, $128, $256, $512, $1024.
To put this into perspective, over my assumed 36 year working lifetime I earn 32 times more money by earning 20% than I would have if I earned 10% (1024/32=32). Doubling the number of doubles over the same timeframe shows the incredible power of compounding the true growth stocks are capable of offering.
9. Earnings Growth Often Easier to Forecast
One of the advantages of investing in pure growth stocks compared to investing in large multinational blue-chip dividend growth stocks is the typical simplicity of their businesses. The typical pure growth stock generally operates in a single industry based on a single idea, especially in the early phases of growth. In contrast, the typical large multinational dividend growth stock often is comprised of many divisions and/or multiple brands adding complexity to the analysis.
Consequently, it is often easier to evaluate the growth potential of the simpler business model. Companies such as Netflix (although I consider the stock significantly overvalued), Priceline, AutoZone, Facebook and Twitter are just a few high-profile examples that come to mind. I am not suggesting that it is necessarily easy to forecast growth on single business pure growth stocks; I am just suggesting that it may be easier than evaluating larger companies with more complex business structures.
10. Growth Stocks Can Add Diversification
Investing in companies whose businesses are based on new inventions and innovations can add growing industries that never existed before to your portfolio. Consequently, pure growth stocks can add a level of diversification to the retirement portfolio that is not available from more traditional dividend paying blue chips.
Moreover, pure growth stocks are often at the forefront of technologies capable of generating creative destruction or disruptions to established industries. Investing in those companies can provide a hedge of sorts against the businesses of established companies you may already own. What Amazon threatens to do to the big-box retailer is just one of many examples.
Summary and Conclusions
The purpose of this article was not to suggest that retired investors should absolutely include growth stocks in their retirement portfolios. The true purpose of this article was simply an attempt to open the reader’s eyes to what true growth stock investing is really all about, and what it potentially offers.
But more importantly, this article was inspired by several questions and comments on the subject of adding growth stocks in retirement portfolios that I have been recently receiving. The following comment from my most recent article where I expressed my support and sang the laurels about dividend growth investing found here is one example and presented in its entirety:
“Chuck, I retired at the end of March, so your articles are a great benefit to me. However, I receive a pension that more than covers the bills until I reach age 62 in four years, at which time the payment will be reduced by 20% (I took an early retirement package with a bonus until age 62).
Under my circumstances, I have been purchasing stocks where I believe there is great current value along with the potential for strong dividend growth. Meaning that there isn’t a history of dividend growth per se. Examples would be AAPL and GILD, both growing earnings much faster than the S&P 500 as a whole, with relatively short periods of paying dividends. I also have 2% of the portfolio in GOOGL. AAPL, GILD, and GOOGL all look to be good values per F.A.S.T.Graphs by the way (and thank you for that service!).
Long story short, my wife and I will be supplementing our income with dividends in 4 years. Do you think that growth stocks are appropriate for someone in our situation? Add DIS, SBUX, V, and MA to the above and it totals approximately 20% of the total portfolio.
Thanks for all your work,
Here’s an excerpt from a response I made to another comment on the same article that the above reader accepted as a response to his question:
“For example, I have advised retired investors in the past that needed to get the maximum return possible at reasonable levels of risk. In these cases, I have included select high-quality growth stocks such as V, MA, GILD, GOOG, AAPL, CTSH and others. On the other hand, for those retired investors that have accumulated adequate assets that could support their lifestyle based on the dividends generated, I believe that a more conservative blue-chip dividend growth stock approach is warranted.”
Therefore, in conclusion, I believe that adding growth stocks to retirement portfolios can be appropriate under certain circumstances. With this article I offered a few reasons and situations where that might be the case. On the other hand, based on the generally lower-risk-profile of high-quality blue-chip dividend growth stocks, I would not assert that they belong in every retired investor’s portfolio. At the end of the day, each individual investor, retired or not, should build portfolios that meet their own unique goals, objectives and risk tolerances. With investing there is no one-size-fits-all. However, awareness of the true nature of all the options available is something that I do support.
Disclosure: Long AAPL and JNJ at the time of writing.
Disclaimer: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the earnings growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. We do not recommend that anyone act upon any investment information without first consulting an investment advisor as to the suitability of such investments for his specific situation.