Ken Kam's Best Ideas Blog

Most of the things the politicians, the media, and big corporations want you to be afraid of, you really don't need to be afraid of. Let other investors on Wall St. run around like chickens and use their fear to create your opportunities to buy stocks in key areas like energy. However, there is one thing I do worry about and so should you: rising interest rates.

Rising interest rates are bad for stock prices and I'm afraid the Federal Reserve is going to raise interest rates too far. In the last 50 years, the Federal Reserve has successfully managed interest rates to produce a soft landing only twice -- a poor track record indeed.

There is an antidote to rising interest rates! It's called growth.

By "growth" I do not mean investing in what Morningstar, and others, commonly refer to as "growth stocks." To be classified a "growth" stock by Morningstar a stock has to exhibit high growth in earnings and a high P/E ratio. A high P/E ratio is all the proof I need that Wall St. has already discovered and priced this stock at a premium. When interest rates rise the stocks with the highest PE's have the farthest to fall so buying these stocks now would make your portfolio more vulnerable to rising interest rates, not less.

The growth stocks I want you to buy are the stocks with high earnings growth, but that Wall St. has not yet discovered. These undiscovered growth stocks have lower P/Es and are likely to be classified as "value" or "blend" stocks and lumped together with lots of other stocks that are selling at low P/Es, and deserve to be.

The fears that have seized Wall St. today have put growth on sale. For example, the energy companies that we recommended in May such as Valero (nyse: VLO) and Edge Petroleum (nasdaq: EPEX) and Chaparral (otc: CHAR) have delivered terrific earnings growth over the past year, but still trade at below average P/Es and are classified by Wall St. as "value" stocks.

I also want you to invest in stocks like Click Commerce (nasdaq: CKCM) with terrific growth prospects that are not tied to the Energy sector and that the market hasn't already discovered.

Click Commerce just reported that for the 3rd quarter revenues grew by 130% and earnings grew by 176%. For all that growth, CKCM trades at a price-earnings ratio of 18, a small premium over the S&P 500, which has a PE of about 16. But I don't need to tell you, that the S&P 500's revenues and earnings have not grown by 130% and 176% since last year. Buying Click Commerce is buying growth at a bargain price.

When earnings grow this quickly, even rising interest rates cannot stop the stock price from going up. Here's why. Suppose that over the next year, CKCM's earnings double (which would actually mean growth slowed to 100% from 176%). For the PE ratio for CKCM to remain the same at 18, its stock price (the "P" in the price-to-earnings ratio) would have to double, since the earnings or "E" doubled. That would be a fantastic outcome.

If interest rates keep rising, the PE of this, and every company, will fall. Rising interest rates increases the discount rate for future cash flow and lowers the net present value. If a company's future earnings grow fast enough, it can out run the rise in interest rates and keep the company's stock price rising. So, if CKCM earnings double, its PE ratio would have to decline more than 50% before the stock price would go down.

The faster earnings grow, the more protected we are from being hurt by rising interest rates. That's why I'm recommending you buy Click Commerce today.

Click Commerce, Valero, Edge Petroleum and Chaparral are the kinds of stocks that should form the core of your portfolio because they provide downside protection and the best opportunity for upside appreciation. But you should have several more stocks in your portfolio to reduce your risk. Over the next few months, I'll be hunting for more.