If I bought a stock now, what would be the optimal place you would want it to be at in regards to growth in price in a year?
The basis of your question is the most important that any investor should be asking. And I’d like to rephrase it because it really isn’t so much about a growth stock (vs a value stock, or a small cap vs large cap). It’s really about risk vs reward.
You are essentially asking what your expected return should be based on the amount or risk that you are taking (specifically for you, the amount of risk that you are taking by buying a growth stock). To give you some context, large cap stocks have historically been less risky than small caps; if you buy small caps, you expect higher returns for taking on more risk. US growth stocks have been less risky than emerging market value stocks. If you buy the latter, you should expect higher returns, otherwise what’s the point of taking on more risk. And that’s what decades of historical data have shown…that there are some market characteristics that lead to higher expected return. These characteristics are what you may sometimes hear in the media as factors, premiums, dimensions, smart beta, etc. Although the value premium has historically had higher returns (vs growth), it’s been missing for the last decade and many are starting to think that it’s actually been priced out (growth stocks have done much better). I think a decade is way too short of a time frame for any meaningful analysis and don’t see any reason to abandon value as a dimension of higher expected returns for the long run. But of course, pundits need talking points.
Now, it’s impossible to answer your question directly. That’s because with individual stocks you are not only exposed to market risk, you are also exposed to uncompensated, company-specific risks. What is that extra risk worth to you?
Let’s put it another way. When you buy an individual stock, you are not so much investing as you are speculating, trying to pick a winner among the thousands. Unfortunately, picking winning stocks, like trying to time the market, is incredibly difficult. The evidence has shown that even the professionals don’t possess that skill. So, if you can’t rely on skill to outwit the markets, you must rely on luck.
Relying on luck is a bit like gambling in Vegas. Of course, there is the opportunity for extraordinary gains. However, for this opportunity you must accept more than the usual amount of risk, even the potential for losing it all. Even if you win sometimes, in the end, over the longer term, the probability is always in the house’s (casino’s) favor. How much risk are you willing to take?
What if instead of trying to beat the house, you were given the opportunity to put your money on the house (you win when the house wins, and you lose when the house loses)? Would you still take your chances, or would you put your money on the house and let others gamble instead? Well, you do have the opportunity to invest in the house right now. Rather than picking individual stocks and speculating, you can own the entire market with a well-diversified portfolio of low-cost index funds. It’s how you tilt the odds of success in your favor.
Of course, the markets are not casinos. However, the idea of how to improve your probability of success does apply to investing. Rather than trying to beat the markets, let them work for you instead. Sometimes they may seem turbulent and out of control. It is your job to remain disciplined during those market dips and swings by sticking to your investment plan for the long term. You’ll be much more relaxed and rational about investing. And the probability of success will be in your favor. Good luck.
Read more answers from Dejan on the Investopedia Advisor Insights Network.