Many investors aim to put top growth stocks into their portfolios because of the expected returns if the stock proves to be a true growth stock and not a momentum stock in disguise.

Finding top growth stocks is one piece to building a growth investment strategy. However, it’s important to not let sound bites and nebulous predictions warp your stock trading decisions.

If you want your growth investing strategy to be profitable for decades, consider our Successful Investor philosophy and follow our tips below.

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To profit from top growth stocks, pick stocks with clear growth prospects that have these characteristics

1. They are not momentum stocks in disguise. It’s very easy to confuse growth stocks with momentum stocks. Like growth stocks, momentum stocks often move up faster than the market averages. But momentum stocks attract a different kind of investor. Growth-stock investors are in for the long haul, while momentum investors aim to profit from short-term trades.

Momentum investors like to invest in companies whose earnings and stock prices are rising. They are largely unconcerned with value considerations such as high p/e ratios or low dividend yields. They don’t care if a stock trades at 50 or even 100 times earnings. They assume that the company’s earnings and sales will continue to rise say, 15% to 17% a year, on average, as they have in the past five years, and that the stock price will do the same.

2. Top growth stocks have hidden assets that can make a world of difference long-term. Hidden assets can make a huge difference in growth stocks in the long term. They are also a key part of our Successful Investor approach. One example of hidden assets is real estate.

 Another example of hidden assets is research and development spending. Technology companies spend large sums of money developing new practices and technologies that can change the world of the future. This research may not pay off for decades, but if you’re a keen investor, you can see via their income statements what companies spend on research and development.

3. Top growth stocks should be free of high debt. When you’re researching growth stocks, you need to know how much debt they’re holding. Growth companies with a lot of debt have a hard time recovering from an economic downturn.

The more manageable the debt, the better. When bad times hit, debt-heavy companies often go broke first. That’s especially true for ones that also keep trying to allocate part of their cash flow to paying dividends.

4. Top growth stocks will typically be multi-product companies. Technological advances, for example, come in spurts and tech companies tend to leapfrog each other. Focus on tech growth stocks with a variety of existing or soon-to-be-released products and avoid one-hit wonders.
5. Growth stocks to invest in often focus on up-and-coming technologies. For this, you need to know how technology is changing. Read and absorb the latest tech blogs. Learn about the technologies that are exciting tech companies. For instance, increasingly pervasive use of wireless devices is raising demand for faster and faster, reliable wireless networks.
6. Top growth stocks have loyalty behind them. Does the growth stock in question have a loyal following? Apple is the perfect example of a tech company that leveraged its loyal fan base to jump start the digital music revolution with the iPod.
7. The best growth stocks will not grow primarily through acquisitions. Making acquisitions can speed up a company’s growth, but that also adds risk, which can undermine a conservative, safe investing approach. Great acquisitions are rare finds. Many acquisitions come with hidden problems, or risks, or they turn out to have been overpriced.

Despite the risks, some acquisitions turn out hugely profitable. So, your Successful Investor strategy shouldn’t automatically discount companies that have grown through acquisitions. Just keep the risks in mind, and avoid companies that seem unaware of them.

8. The best growth stocks should have the ability to profit from secular trends. These trends outlast ordinary business booms and busts because they reflect ongoing social change. Free trade and rising environmentalism are just two examples of secular trends.
9. Seek steady—not outsized—returns from top growth stocks. You can’t expect to earn an outsize return indefinitely. If you did, you’d wind up with a measurable fraction of all the money in the world, and nobody ever does that.

Regression to the mean is inevitable. No investor and no investment can earn an outsized return indefinitely. Eventually, a high yearly return will come back down toward average.

Have you mistaken momentum stocks for growth stocks? How did that impact your portfolio?