While many investors get enamored with stocks of fast-growing companies, Wharton Professor and author Jeremy Siegel says that too often such investors get lured into the “growth trap”.
“The growth trap is the belief by investors that they should buy the companies that have the fastest earnings growth,” Siegel tells The Washington Post. “The trap is they don’t pay enough attention to the price at which they’re paying for this growth.”
Siegel says it’s a common mistake. “The historical evidence is very overwhelming that investors overpay for growth,” he said. Examples, he said, include Exxon and IBM. “IBM was the Facebook of its time in 1950,” writes the Post’s Cezary Podkul. “The computing revolution was imminent, and its shares were poised for much faster growth than Standard Oil of New Jersey, Exxon’s predecessor. Had you invested $1,000 in IBM in 1950, you would now find your investment worth 33 percent less than if you were cashing out Exxon Mobil shares, Siegel said. As far as earnings per share, investors in Jersey Standard finished almost three-quarters of a percentage point ahead.”
That difference is huge over the long haul, Siegel says. “IBM was a much faster-growing company on earnings, on sales, by any stretch,” he said. “But Exxon Mobil gave better returns to shareholders because its price was much more reasonable.”