“Only when the tide goes out do you discover who’s been swimming naked.” — Warren Buffett.
After the amazing gains of 2013, this year has been a sobering experience for many investors. Emerging markets have fallen, banks have taken a tumble, and small-cap growth stocks have also pulled back. Across a range of equity markets, we have seen a clearing of the froth.
Eye-watering falls
The share prices of growth companies such as Blinkx (LSE: BLNX), Quindell (LSE: QPP) and Globo have suffered eye-watering falls. How can investors react to this?
Well, my advice is two-fold.
Regular readers will know I keep harping on about this, but firstly I would say: always check the fundamentals. Never take anyone else’s word for it — always do your own research.
Check the P/E ratio, both current and future. Check the dividend yield, the net debt and the share price chart. What is the long-term trend? Read the company report. The more you can research the company, the better.
And secondly, think contrarian. The big downside with investing in small-cap growth shares is that they can be very volatile. But, if you buy into a share after it has crashed, rather than before, then you can turn this volatility to your advantage.
But to think contrarian, you also need to control your emotions and have the composure so that you are not too elated when the share price rockets, and not panicking when the share price tumbles. If you find yourself thinking about panic-selling every time the share price falls then perhaps small-cap growth shares are not for you.
Not all growth companies are alike
I have watched the Blinkx story with interest. But this was never a company I considered investing in, as I have always thought it was too expensive. The share price peaked at over 200p. It is now down to 35p. So, certainly by the contrarian yardstick this looks cheap. Yet, even now, after the crash, the P/E ratio is 18, which to me is still not particularly cheap, even though it is a growing company. So I won’t be investing.
Compare this with Quindell. The recent crash means this may be a contrarian buy. And the fundamentals are strong, too: this is one of the fastest growing companies in the UK. It has minimal net debt. Yet the shares are on a P/E ratio of 3. This is why I have recently added to my holding in this company.
Not all growth companies are alike. Growth investing is difficult, and does not suit everyone. But this is no reason to lose faith in growth shares.
