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Cramer: Don't Throw All Your Eggs into One High-Growth Basket

Wednesday, 6 Jun 2012 | 6:19 PM ET

Momentum feeds on momentum, and right now, one chain of beauty superstores is dragging up all the other high-growth stocks in that sector, Jim Cramer said Wednesday on CNBC's "Mad Money." That beauty store brand was Ulta Salon, Cosmetics & Fragrance.

Maintaining a well-diversified portfolio of stocks across a variety of sectors is always key, and high-growth stocks do, in fact, make up a sector of their own.

With earnings up 47 percent over the last quarter and an impressive comparable sales increase of 10 percent, Ulta is a real high-growth stock, he said. The company's gross margins have also edged higher and the firm has rapidly begun to expand its store base by over 700 stores — "music to the ears of every growth investor out there," Cramer said. Ulta also boasts a mid-sized market cap of $5 billion and has raised its sales and earnings guidance substantially.

Even so, the "Mad Money" host isn't recommending the stock. In fact, he called the Ulta story a cautionary tale about what might happen when investors chase too much momentum. "You have to be skeptical as insider selling raised red flags, and you can’t get comfortable with super high-speed store growth," he said. "As we have seen that wreck many a good company."

Cramer: Beware of Chasing Too Much Momentum
Ulta reported earnings increased an astounding 47%, and its comparable sales number increased 10%. Mad Money host Jim Cramer, explains what investors can learn from this growth stock.

But at the end of the day, Ulta brought plenty of other growth stocks higher, as companies like Chipotle, Panera Bread, Whole Foods and Ralph Lauren all ramped up gains in Wednesday trading. And while this might seem absurd to some, Cramer broke down the mechanics of how growth investing works. When an expensive stock like Ulta — which currently trades at 46 times earnings — blows away expectations and surges higher, the mutual funds that own those stocks feel empowered to take similar stocks and sell them at a premium multiple. "Momentum feeds on momentum," he reiterated.

The bottom line: The high-growth sector is indeed a sector, and investors shouldn't overexpose themselves to that sector or they'll risk their entire portfolio on one "nasty earnings report from just one of the cohort's companies," he said. "When one stumbles, they all stumble."

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