Growth stocks are companies whose earnings growth has been above the market average, and is likely to remain above average. These firms often pay little or no dividends. Instead, they invest their free cash flow in furthering their growth.

These stocks can be highly volatile, but they often make good long-term investments. They can be well-known stars or quiet gems, but they share the common trait of growing at a higher than average rate within their industry, or within the market as a whole, for many months or years.

Here are 2 keys to cutting your risk and earning higher profits when investing in growth stocks:

1. Know the difference between growth and momentum stocks: It’s all too easy to confuse growth stocks with momentum stocks. Like growth stocks, momentum stocks often move up faster than the market averages. But unlike growth-stock investing, the overall goal of momentum trading is to profit from short-term trades. Momentum investors are particularly keen on the so-called “positive earnings surprise.” That’s when a company outdoes brokers’ earnings estimates.

   Momentum players view a “negative earnings surprise” — lower-than-expected earnings — as a sell signal. They use a variety of computerized formulas to make buy and sell decisions, but all come down to “buy on strength and sell on weakness.” So they tend to pile into the same stocks all at once, and the gains that follow are something of a self-fulfilling prophecy.

   The trouble is that when the stock’s rise falters, momentum investors also try to get out as a group, but there are never enough buyers. That leads to violent price fluctuations in the stock’s price.

For a rising portfolio Learn everything you need to know in 'How to Find the Best Growth Stocks' for FREE from The Successful Investor. Canadian Growth Stocks: CGI Group, CAE Inc., Fortis Inc. Stock and more.  I consent to receiving information from The Successful Investor via email. I understand I can unsubscribe from these updates at any time.

2. Value stocks can offset risk in your growth stocks: Most successful investors own some growth and some value stocks at any given time, depending on where they see the best opportunities.

   Value stocks are stocks trading lower than their fundamentals suggest. They are perceived as undervalued, and have the potential to rise. Many technology stocks, such as IBM (symbol IBM on New York), started out as growth picks, but have begun the transition into value stocks.

   Growth stocks plus value stocks can make a winning combination in your investment portfolio. A growth stock can be a top performer when the company is growing. However, a single quarter of bad earnings can send it into a deep, but often temporary, slide. Value stocks can test your patience by moving sluggishly for months, if not years. But they can make up for it by suddenly shooting up when investors discover their true value.

Investment opinion: If you invest as we advise (by spreading your investments out across the five main economic sectors, investing mainly in well-established companies and downplaying stocks that are in the broker/public relations limelight), you will automatically buy some growth stocks and some value stocks.

That helps you achieve good results while holding down volatility. But in the end, we think the relative amounts you invest in growth and value stocks should be secondary to your portfolio’s diversification and overall investment quality.

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