The Four Types of Growth Stocks

 | Apr 11, 2014 | 11:41 AM EDT  | Comments
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We hold these truths to be self-evident that not all growth stocks are created equal.

Well, at least I hold them to be self-evident because a lot of others don't, so they all start trading down in unison, even as they shouldn't.

So let's go through the phyla, so everyone knows what the heck I am talking about and what we are doing.

First, there's what I call the faded growth stocks. These are the ones that used to be high growers, but have slowed and are now chiefly income stocks. That means Pfizer (PFE) and Merck (MRK) in pharma, McDonald's (MCD) in fast foods, General Mills (GIS) and Kellogg (K) in processed food and Procter & Gamble (PG) and Kimberly-Clarke (KMB) in non-food consumer packaged goods.

As interest rates go down like they have, the money gravitates to these classic slow growers because they tend to yield 3% or more. You get growth at a bit of a high price that comes with consistency, with an after-tax yield that is superior to Treasuries. Given that these companies tend to have magnificent balance sheets, they are much better bets than the 10-year. Plus, you always have a chance for a restructuring and dividend boosts with ample buybacks. Just this week we got P&G offloading its pet food business while boosting its dividend by 7%. That's a quintessential trait of this group.

Then you have more cyclical growth stocks with some decent yields and right now those are clustered in old tech, namely Cisco (CSCO), Microsoft (MSFT) and Intel (INTC). These stocks have become Rocks of Gibraltar. They don't climb a lot because their earnings have been inconsistent, but if the economy's getting better you are being paid to wait. They are totally in vogue right now.

Then there are the classic growth stocks themselves, companies like Starbucks (SBUX) and Gilead (GILD), which are fast-growing, lucrative companies with excellent franchises. We have often been willing to overlook the faults and flies on these stocks because we like their nice double-digit growth. But lately we have done the opposite.

Gilead, for example, has an amazing drug for Hepatitis C available right now that is saving many lives. That's a huge win. But Merck has what looks to be a similar drug that is Phase II. The fact that a drug in Phase II, which, we know, is far away from FDA approval, is regarded as a direct threat to the already-agreed-upon course of action is this moment writ large.

It's the same with Starbucks and the price of coffee. The fact that coffee has gone up a great deal in price is all I hear when I talk about Starbucks, not that they have dealt with the coffee price volatility for years under Howard Schultz and battled it successfully. It is not Howard's first rodeo.

Still, these stocks are toxic. But they aren't as toxic as the high-flying techs, like the software-as-a-service companies out there. Now again, there are two types of companies within this grouping, the kind that show exceptional cash flow per share and could be profitable right now if they wanted to be and the kind like we have seen come public endlessly in the last few months, ones that may never reach profitability. This market was willing to overlook just about every company's potential earnings-per-share numbers and focus on bidding up companies with massive revenue growth that told us gunning for profit might mean lost opportunity. Those are what are really being dumped.

Same thing with biotech, by the way, as so many development-stage biotechs are coming public that the whole group is being brought down as people buy these stocks for the pop and short the biotech ETF for protection. The insider selling in all of these stocks is dreadful and endless.

Finally there are the cult stocks that are run entirely for revenue growth, period. I am talking about Amazon.com (AMZN), SolarCity (SCTY), Tesla (TSLA) (strip away the subsidies) and Netflix (NFLX). They have been sold and shorted here as polar opposites of all the slower growth stocks and the growth cyclicals.

Now, this rotation is vicious, but it will end and I do not think it ends as viciously as it begins because, unlike 2000, when the destruction was violent and everything was laid to waste, we are getting to where high growth, even profitable high growth, is getting to a reasonable price. Any sign of a cessation in IPOs and insider selling, coupled with some decent earnings and the opportunities will abound.

Just keep these differences in mind and you'll know when things are overdone for both slow and fast growth and the endless reversion from value to growth will begin again.

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