Rules of the Game: Identifying Growth Stocks

 | May 10, 2013 | 12:00 PM EDT  | Comments
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I have been on a rampage lately about thoughtful portfolio construction rather than trading. This is one of those "gets my goat" issues, because I have taught trading classes in which most attendees had no clue as to why they were trying to identify growth stocks that were flashing particular technical signals.

To be clear, I have absolutely nothing against high-beta growth stocks as part of a well-thought-out portfolio. Plenty of professional asset managers have plans for buying, selling and holding these stocks as a means to achieve a specific objective.

But too many individual investors get caught up in one methodology or other, and lose sight of the end game. What is their why? In other words, why are they chasing high-beta names and trying to master the art and science of technical analysis?

Most would say, "To make money." But that's the wrong answer. The objective of investing is to offset future liabilities. Risk management, in the form of keeping pace with inflation, is another objective. Trying to beat some random and arbitrary index, such as the S&P 500, can be a setup for risky trades.

Having said all that, I wanted to point out some of the large-cap growth names we hold in our equity portfolio for clients. It's crucial to make this distinction: We do not view these as short-term trades, but instead as medium-term holdings.  That means the pullbacks are not automatically a signal to panic and run screaming into cash. Pullbacks often mean an opportunity to add to a position that still has room to run.

I've written before about AbbVie (ABBV), the pharmaceutical spinoff from Abbot Labs (ABT). The stock made its debut on the first trading session of this year, and has advanced nearly 30% since then. The lion's share of revenue, 45%, comes from its flagship product Humira, a rheumatoid arthritis treatment.

Analysts expect the company to earn between $3.11 per share this year, which would a 7% year-over-year decline. That's not particularly "growthy," but we like its longer-term prospects, and view occurrences such as the current pullback as opportunities to add shares.

Though the company is heavily dependent on one product, Humira's prospects look good. In addition to rheumatoid arthritis, it also has approval to treat Crohn's disease and psoriasis. With its planned launches of hepatitis C treatments, the company's product pipeline for 2015 looks promising.

Another large-cap growth holding is MasterCard (MA). After a two-year run in which its share price more than doubled, valuation metrics are looking a little stretched. Some analysts believe that consensus forecasts for 2013 and 2014 are a tad aggressive. The past couple years of out-sized performance boosted investor expectations, with consensus estimates calling for double-digit earnings gains this year and next.

While continuing to make investments for the future, the company has closed the operating margin gap and revenue growth gap with its rival, Visa (V). MasterCard's management team has done an excellent job at setting conservative guidance and then exceeding it. To that end, given the uncertain global economy, MasterCard was prudent to slash the low end of its 2013-15 revenue growth range. It now forecasts growth of 11% to 14%, down from an earlier estimate of 12% to 14%.

Given the stock's advance over the past couple of years -- and while it is perched on new high ground -- investors may want to consider taking some profits.

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