When Good Growth Stocks Go Bad

By Mike Cintolo, Vice President of Investments and Chief Analyst, Cabot Growth Investor and Cabot Top Ten Trader

You must always remember that Wall Street is a two-way street, and that not only goes for the market as a whole, but also for individual stocks … even those with tremendous growth. Many investors like to believe that most leading stocks will rise forever, or, failing that, will meander for a couple of years before getting going again. But that’s not what actually happens.

Remember this historical fact: The biggest winners in market history, once they’ve topped, have fallen more than 70% from their peaks before reaching their lows. 70%! Yes, even though sales and earnings continue higher for a few quarters after the top.

Why such drops? As usual, it comes down to institutional investors—their consistent buying drives a leading stock up for 12 to 24 months (on average), but at some point, selling pressures (from those who bought early and want out) balance the buying pressures. Eventually, the tide shifts, and when most big investors want out, they can drive prices lower in a hurry, and without much of a rally. Essentially, the huge upmoves create pent-up selling pressures that, when the time is right, result in much lower prices.

When you have a stock that acts this way, you shouldn’t spend all day trying to find the reason why the stock has broken down; usually the real reason is revealed a few weeks after the stock breaks. Besides, we’re talking about the stock, and not the company. If investing were as simple as buying good companies, we’d all be rich.

The big thing to remember is that when sellers have the upper hand, and when this happens following a mega-advance, a growth stock often falls sharply for weeks and months. Could the stock come back? Of course—anything is possible in the stock market. But given its action and the market environment, the odds favor further downside in the weeks and months ahead.  SELL.

Interpret, Don't Predict

The bottom line: Don’t be too quick to predict what the market will or won’t do. It’s not your opinion that counts, nor ours, nor that of the pundit you just watched on TV. The market’s opinion is the only one that truly counts. So stay flexible, and you’ll be ready to get in early on the next bull market, whenever it begins.

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More on Growth Investing

Growth Investing involves a greater degree of volatility than dividend or value investing, but it has the potential for bigger rewards. Find out how.

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