Growth Funds' Time in the Sun

10/08/2007 12:00 am EST

Focus: STOCKS

Richard Band

Editor, Profitable Investing

Richard Band, editor of Profitable Investing, says large growth stocks have broken out and he recommends three funds he thinks will benefit from the trend.

Because of their superior growth characteristics, “growth” stocks typically sell at much higher price/earnings ratios than “value” stocks. Since 2000, however, the premium investors are willing to pay for brisk earnings growth has shriveled. In fact, growth stocks are about as cheap, relative to value stocks, as I’ve seen them in the past 15 years.

Over the past year or so, growth stocks have stopped losing ground to value stocks—and, since early July, they’ve staged an impressive up side breakout. Before this bull breathes his last, I look for growth stocks (and growth funds) to put on an exciting fireworks show.

Small-cap funds should perform reasonably well over the next 12 to 18 months, but investors normally gravitate to larger, safer companies in the final innings of a bull market (a la 1987 or 1999). Put most of your money on large caps from this point forward.

Fidelity Large-Cap Stock (FLCSX) is my all-around favorite. More stable in its monthly price swings than your typical growth fund, FLCSX nonetheless racked up a higher return than its peers in 2005 and 2006, and is replicating the feat in 2007. Manager Matt Fruhan, a 12-year Fidelity veteran, has plowed a hefty 7% of the fund’s assets into that bluest of blue chips, GE, but new-tech darling Google also ranks in fund’s 10 largest holdings.

Joel Fried of Vanguard PRIMECAP Core (VPCCX) is an old hand in the growth arena, having worked for PRIMECAP (the outside firm Vanguard hired to run the fund) since 1987. PRIMECAP Core doesn’t take many large positions in relatively few stocks. As a result, there’s less chance that a blow-up at any one company might hurt the fund’s overall performance. Furthermore,—in keeping with the Vanguard philosophy—it boasts a low annual expense ratio of just 60 cents per $100 invested, as well as a rock-bottom 5% annual turnover rate. By keeping overhead and capital gains taxes low, the fund helps fend off the two biggest drags on your investment results.

With the iShares Russell 1000 Growth Index Fund (NYSE: IWF), you never have to worry that your manager might pick the wrong stocks, because you’ll automatically own all the leading growth names among America’s 1,000 largest publicly traded corporations.

What’s more, IWF [charges] a microscopic 20 cents a year per $100 under management. Taxes are held to a minimum, too: Since 2001, its first full year in business, IWF has never declared a capital gains distribution. Of course, the fund does pass along (quarterly) any dividends paid by companies in its portfolio.

It’s possible for a talented “live” growth manager to beat the index over an extended period—[but] you might allocate 25% (or so) of your growth-stock pot to an index fund like IWF. That way, you can be sure you’ll keep up when the thundering herd goes stampeding off. Buy IWF at $62.30 or less.  (It closed Friday just below $63—Editor.)

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