****Buffett (1992): Do not categorise stocks into growth and value types, the two approaches are joined at the hip

 

****Buffett (1992): Do not categorise stocks into growth and value types, the two approaches are joined at the hip

https://myinvestingnotes.blogspot.com/2010/04/buffett-1992-do-not-categorise-stocks.html

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Here is a summary of Warren Buffett's key points from his 1992 shareholder letter:

Core Argument: The traditional division between "value" and "growth" investing is a false and unhelpful dichotomy. True investing is always about seeking value.

Key Takeaways:

1. Growth and Value Are Inseparable: Growth is a critical component in calculating a business's intrinsic value. Its impact can be positive, negative, or negligible, but it is always a variable in the valuation equation.

2. "Value Investing" is Redundant: All legitimate investing is the pursuit of value. Paying more for a stock than its calculated intrinsic value is speculation, not investing.

3. Surface Metrics Are Misleading: Traditional "value" indicators (low P/E, low P/B, high yield) or "growth" indicators (high P/E, high P/B) are not definitive. A stock with a high P/E can still be a "value" purchase if its intrinsic value is even higher.

4. Growth Alone Does Not Create Value: Growth only benefits investors when the business can generate returns on its incremental capital that exceed its cost of capital. Profitable growth that consumes vast amounts of capital can destroy shareholder value (e.g., the airline industry).

5. The Crucial Metric is Return on Capital: The primary determinant of value is not profit growth itself, but the amount of capital required to achieve that growth. The lower the capital consumed for a given level of growth, the higher the intrinsic value.

Practical Investor Lesson: Investors should avoid companies and sectors where fast profit growth is accompanied by low returns on capital employed (below the cost of capital). The focus must be on the relationship between growth, capital required, and the resulting returns.

Growth stocks as a class has a striking tendency toward wide swings in market price

  

Growth stocks as a class has a striking tendency toward wide swings in market price (II)

https://myinvestingnotes.blogspot.com/2010/02/growth-stocks-as-class-has-striking.html

The striking thing about growth stocks as a class is their tendency toward wide swings in market price.

But is it not true, that the really big fortunes from common stocks have been garnered by those 

• who made a substantial commitment in the early years of a company in whose future they had great confidence and 
• who held their original shares unwaveringly while they increased 10-fold or 100-fold or more in value?

The answer is "Yes."  

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This is a fascinating and central tension in investing philosophy, pitting the romantic ideal of the "visionary founder or early backer" against the cold, hard statistics of market behavior.

Let's break down the provided statements, elaborate, discuss, critique, and then summarize.

Elaboration and Discussion

The two paragraphs present two seemingly contradictory truths about growth stocks and wealth creation.

1. The General Rule (The "Striking Tendency"):

   • What it means: Growth stocks, as a category, are inherently volatile. Their prices are not tied to stable, current earnings but to expectations of future earnings. These expectations are based on narratives, forecasts, and sentiment, all of which can change rapidly.

   • Why it happens:

     • Speculative Fever: Good news can lead to euphoria, driving prices to unsustainable heights.

     • Disappointment & Fear: A single missed earnings target, a new competitor, or a shift in the economic landscape can shatter the narrative, leading to a brutal sell-off.

     • High Valuations: Since they often trade at high Price-to-Earnings (P/E) ratios, even small changes in future growth projections can lead to large swings in the present value calculation.

2. The Path to Extreme Wealth (The "Big Fortunes"):

   • What it means: The legendary returns in the stock market—the kind that create generational wealth—do not typically come from trading in and out of stocks. They come from identifying a truly exceptional company early and having the conviction to hold onto it through thick and thin, allowing the power of compounding to work over many years or decades.

   • Iconic Examples: Think of early investors in companies like Amazon, Apple, Tesla, or Microsoft. Those who held on through the dot-com bust, the 2008 financial crisis, and countless periods of doubt were rewarded with life-changing returns.

The Synthesis: These two ideas are not opposites; they are two sides of the same coin. The very volatility that defines the class of growth stocks is the price of admission for the astronomical returns of the few individual winners. The "wide swings" include the dramatic upward swings that create 100-baggers. You cannot have the latter without the former.

Critique and The Crucial Caveats

While the "buy, hold, and get rich" narrative is powerful and true in specific cases, it is critically important to understand its limitations and the survivorship bias it contains.

1. Survivorship Bias is Overwhelming:
   This is the most significant criticism. For every Amazon that succeeded, there are dozens of companies like Pets.com, Webvan, or countless other tech, biotech, and growth companies that failed completely or never lived up to their hype. We hear the stories of the winners; the losers are forgotten. The narrative asks "Is it not true that the really big fortunes...?" but ignores the more common question: "Is it not true that the really big losses have been garnered by those who made a substantial commitment in the early years of a company that ultimately failed?"

2. The Difficulty of "Great Confidence":
   Having "great confidence" in a company's future is easy in hindsight. In the present, it is exceptionally difficult to distinguish the next Apple from the next BlackBerry. Many companies that seemed like sure bets were disrupted by new technology or mismanagement. The business landscape is littered with "can't lose" companies that lost.

3. The Psychological Torture of "Holding Unwaveringly":
   Holding through a 50% or even 90% decline is emotionally devastating and goes against every human instinct for self-preservation. Most investors lack the temperament for it. Furthermore, during these "wide swings" downward, the financial media and your own brain will scream at you to sell. The few who succeed in holding are often either extraordinarily disciplined, oblivious, or the founders themselves who have inside information and control.

4. The Opportunity Cost:
   "Holding unwaveringly" requires immense patience and capital that is locked away for decades. During that time, an investor might miss other, more reliable compounding opportunities. A strategy of holding an S&P 500 index fund, while less glamorous, has proven to be a more consistent and less risky path to wealth for the average person.

5. The Question of "When to Sell":
   The narrative glorifies buying and holding but is silent on when, if ever, to sell. No company grows at an explosive rate forever. Eventually, most become large, mature, and slower-growing. Is it still the right move to hold? The 100-fold return in Microsoft from the 80s to the 2000s is legendary, but an investor who held from 2000 to 2013 would have seen zero price appreciation. Timing the exit, or at least rebalancing, is a complex part of the equation.

Summary

In conclusion, the provided text highlights the core paradox of growth investing:

• As a class, growth stocks are characterized by high volatility ("wide swings in market price") due to their dependence on uncertain future prospects.

• However, the only way to capture the legendary, life-changing returns from the stock market is to identify specific companies from within this volatile class, invest meaningfully in them early, and possess the rare combination of foresight and fortitude to hold them through extreme market fluctuations until they multiply in value many times over.

The critical takeaway is that the second path, while true and proven by historical examples, is far more difficult, risky, and rare than the romantic narrative suggests. It is the exception, not the rule. For every investor who achieves a 100-bagger return, countless others see their early-stage "conviction" bets evaporate. Therefore, while the strategy of buying and holding growth stocks is a valid path to extreme wealth, it should be pursued with a clear understanding of the immense risks, the powerful role of luck, and the psychological challenges involved. For most, a diversified approach that acknowledges the "striking tendency" of growth stocks to be volatile may be a more prudent long-term strategy.

Two major schools of investing: Quality Investing and Value Investing.

 Quality versus Net asset value bargains

Quality: Price today $12. Price in 5 years? Net asset value bargains: price today is $12 and its intrinsic value should be $18. Is it always better to buy compounders? Is it always better to buy growth? If you are buying an asset because it is cheap, is your upside limited? Is buying cheap assets the name of the game? Must you always focus on cheap assets? You should look for both: good and cheap. The greater the margin of safety the higher the potential return. Always demand a huge margin of safety.

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This is an excellent set of statements that gets to the very heart of the debate between two major schools of investing: Quality Investing and Value Investing.

Let's break down, analyze, and expand on each point, culminating in a critical opinion.

Analysis & Expansion of the Statements

1. "Quality versus Net asset value bargains"

• Quality (The Compounder): The statement "Price today $12. Price in 5 years?" is the essence of investing in quality compounders. The focus is not on a static intrinsic value, but on the company's ability to grow its intrinsic value over time. You are betting on the company's durable competitive advantages (moat), excellent management, high returns on capital, and its ability to reinvest earnings at high rates of return. The future price is a function of this growth. If earnings per share double, the share price is likely to follow.

• Net Asset Value (NAV) Bargains (The Cigar Butt): This is classic Ben Graham-style deep value investing. The company may be mediocre, but it's selling for significantly less than its liquidation value or a conservative estimate of its current assets. The premise is that the market is irrationally pessimistic, and eventually, the price will converge to its intrinsic value. The upside is the gap between $12 and $18. This strategy often involves assets that are "one puff" stocks—you buy them cheap, they revert to mean, and you sell.

2. "Is it always better to buy compounders? Is it always better to buy growth?"

• The Allure: It seems obvious. Who wouldn't want to own a business that becomes more valuable every year? In theory, yes, it's better.

• The Critical Reality:

  • The Price Problem: The biggest risk with compounders and growth stocks is overpaying. A wonderful company bought at a ridiculous price becomes a bad investment. If you overpay for growth, you can experience years of poor returns even as the company executes perfectly (see many tech stocks in the early 2000s).

  • The Prediction Problem: Identifying a true long-term compounder in advance is incredibly difficult. Industries change, moats erode, and today's superstar can be tomorrow's dinosaur. The "growth" you see might be cyclical, not secular.

  • The Impatience Problem: The market can be irrational in the short term. Even a genuine compounder can stagnate for years before its value is recognized, testing an investor's conviction.

3. "If you are buying an asset because it is cheap, is your upside limited? Is buying cheap assets the name of the game? Must you always focus on cheap assets?"

• The "Cigar Butt" Limitation: Yes, the upside in a pure net asset value bargain is theoretically capped. Once the price reaches intrinsic value ($18 in the example), the reason for holding the stock disappears. You've captured the margin of safety. This is what Charlie Munger called the "cigar butt" approach—one or two puffs of profit, and then you have to find another.

• Is it the "Name of the Game"? For pure deep-value investors, yes. Their entire philosophy is built on buying dollars for fifty cents, repeatedly.

• The "Value Trap" Danger: The critical risk of only focusing on cheap assets is the value trap. A stock is cheap for a reason—its business may be in permanent decline. Its assets may be eroding, or its earnings may be disappearing. The "cheap" price can get even cheaper if the intrinsic value falls faster than the price. You have a margin of safety on the balance sheet, but no safety from a deteriorating business.

4. The Synthesis: "You should look for both: good and cheap. The greater the margin of safety the higher the potential return. Always demand a huge margin of safety."

This is the evolved, modern view of value investing, heavily championed by Warren Buffett after his influence from Charlie Munger.

• "Good and Cheap" (The "It's-Fat-Pitch" Investing): This is the holy grail. It means finding a high-quality business with a durable competitive advantage, trading at a price that provides a margin of safety. You are not just buying a cheap asset; you are buying a growing stream of future cash flows at a discounted price.

• Margin of Safety Redefined: For a compounder, the margin of safety isn't just the gap between price and current assets. It's the gap between the price you pay and your conservative estimate of the company's future intrinsic value. A "huge margin of safety" protects you from:

  1. Errors in your analysis (you were wrong about the quality).

  2. Unexpected bad luck (industry disruption, recession).

  3. The inherent unpredictability of the future.

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Critical Opinion

The progression of these statements mirrors the evolution of smart capital from rigid dogma to a more pragmatic, synthesized philosophy.

1. The Duality is False, but the Tension is Real: Pitting "Quality" against "NAV Bargains" as a strict either/or is a false dichotomy. The most successful long-term investors seek to unite them. They want to buy a wonderful business at a fair or bargain price. The real tension is in the trade-offs: How much quality are you willing to sacrifice for a deeper discount? How much of a premium are you willing to pay for superior quality?

2. "Always" is a Dangerous Word in Investing: The statements "Is it always better..." and "Must you always focus..." are traps. The market is a dynamic ecosystem. There are periods when growth stocks are wildly overvalued and deep value is the only rational choice. There are other periods when the economy is so disruptive that the few true compounders are the only assets that can thrive. A rigid strategy that ignores market context is fragile.

3. The Superior Framework: The final synthesis—"look for both good and cheap"—is the most robust framework. It acknowledges that what you buy (the business quality) is ultimately more important than what you pay for it, but it crucially adds that what you pay determines your return. Paying too much for quality can lead to mediocre returns, while buying a poor business because it's cheap can lead to permanent capital loss.

4. Margin of Safety is the Bedrock: The concluding emphasis on a "huge margin of safety" is the non-negotiable element that ties it all together. It is the principle that manages risk and acknowledges the limits of human foresight. Whether you're valuing a stagnant net-asset bargain or a high-flying compounder, demanding a significant discount to your calculated intrinsic value is the single most important discipline an investor can have.

Conclusion:

The initial statements chart a path from a simplistic, binary view of investing to a sophisticated, nuanced one. The optimal strategy is not to choose between Quality and Value, but to seek the intersection of both, guided always by the discipline of a Margin of Safety. This approach avoids the value traps of cheapness-alone and the capital destruction of overpaying for growth. It is the difference between being a mere "trader of cigar butts" and being a "business owner" for the long term.

How to find good growth stocks?

Finding good growth stocks is a blend of art and science. It involves identifying companies that are not just growing, but growing at an accelerating pace and are positioned to do so for the foreseeable future.

Here is a comprehensive guide, broken down into a philosophical framework, a practical checklist, and the tools to get started.

The Core Mindset: What is a "Growth Stock"?

First, understand what you're looking for. A growth stock is a share in a company whose earnings or revenue are expected to grow at a significantly faster rate than the market average. These companies often reinvest their profits back into the business (so they may not pay dividends) and are typically in expanding industries.

Key Principle: You are betting on the future potential of the company, not just its current value.

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The Step-by-Step Process to Find and Evaluate Growth Stocks

Think of this as a funnel: you start with a broad universe of ideas and then apply increasingly strict filters to find your best candidates.

Step 1: Idea Generation - Where to Look

You need a starting point. Here are the best places to find promising companies:

1. Your Own Experiences: What products and services are you and your friends obsessed with? Are you using a new software at work that's a game-changer? Is there a brand your children must have? (This is how many people found Apple, Netflix, and Amazon early on).

2. Industry Trends and Megatrends: Identify powerful, long-term shifts in the economy and society.

   • Artificial Intelligence (AI) & Automation

   • Cloud Computing

   • Digital Payments & FinTech

   • Electric Vehicles (EVs) & Clean Energy

   • Genomics and Biotechnology

   • Cybersecurity

3. Screening Tools: Use stock screeners to mechanically find companies meeting specific growth criteria. (See "Essential Tools" section below).

4. Expert Analysis & News: Read reputable financial news (Bloomberg, Reuters, The Wall Street Journal) and follow insightful investors and analysts. Don't take their word as gospel, but use them for ideas.

Step 2: The Quantitative Checklist - The Numbers

Once you have a candidate, dig into the financials. These are the non-negotiable metrics for a growth company.

Step 3: The Qualitative Checklist - The Story

The numbers tell you what is happening; the qualitative analysis tells you why and if it can continue.

1. Durable Competitive Advantage (The "Moat"): What prevents competitors from stealing their customers?

   • Network Effect: The service becomes more valuable as more people use it (e.g., Visa, Facebook, Uber).

   • Brand Power: A trusted, must-have brand that allows for premium pricing (e.g., Apple, Nike).

   • Cost Advantage: Can produce goods or services cheaper than anyone else (e.g., Amazon in retail, Costco).

   • Intellectual Property: Patents, trademarks, and regulatory licenses that block competition (e.g., pharmaceutical companies, sophisticated software).

2. Total Addressable Market (TAM): Is the company operating in a large and growing market? A company with a great product in a small niche will eventually run out of room to grow.

3. Strong Management: Look for a founder-led or visionary leadership team with a clear long-term vision and a track record of execution. Read shareholder letters and listen to earnings calls.

4. Scalable Business Model: Can the company grow revenue much faster than its costs? Software is the classic example—it costs very little to duplicate and sell a software program for the millionth time.

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Essential Tools for Your Research

• Stock Screeners: Finviz, Yahoo Finance, TradingView. Use them to filter for stocks with, for example, "Sales Growth YoY > 25%"

• Financial Data: Yahoo Finance (user-friendly), Bloomberg Terminal (professional), Morningstar (in-depth analysis).

• Company Communications: Listen to quarterly earnings calls (found on investor relations pages). Read the annual report (10-K) and quarterly report (10-Q) filed with the SEC.

Common Pitfalls to Avoid

• Chasing Past Performance: A stock that went up 500% last year isn't necessarily a good buy today. Focus on the future growth potential.

• Ignoring Valuation: Even the best company can be a bad investment if you pay too much for it. A high P/E ratio requires even higher growth to justify it.

• Confusing a Good Product with a Good Business: A product can be revolutionary, but if the company can't monetize it effectively, it's not a good stock.

• Lack of Patience: Growth investing requires a long-term horizon (5+ years). Volatility is normal. If you believe in your research, hold through the ups and downs.

A Practical Example: How You Might Have Spotted NVIDIA Early in the AI Boom (Circa 2016-2018)

1. Idea Generation: You read about the rise of AI, machine learning, and data centers. You identify that all these fields require immense processing power.

2. Qualitative Check: You research and find that NVIDIA's GPUs are uniquely suited for this task, not just for gaming. They have a huge moat (dominant market share, complex IP) and a massive TAM (AI, cloud, autonomous vehicles). Management is focused on this shift.

3. Quantitative Check: You look at the numbers. Revenue from the Data Center segment is exploding (e.g., growing 50%+ YoY). Gross margins are high and stable. Earnings are following suit. The PEG ratio, while not cheap, is justified by the incredible growth rate.

4. Decision: You conclude that NVIDIA is not just a chip company but a foundational pick for the AI megatrend and decide to invest.

Final Word

Finding good growth stocks is a skill that takes time and practice. It requires diligent research, a healthy skepticism, and the emotional fortitude to think long-term.

Start by paper trading: Build a mock portfolio and track your picks for 6 months. See how your research holds up before committing real capital.

Disclaimer: This information is for educational purposes only and does not constitute financial advice. All investing involves risk, including the possible loss of principal.

The importance of growth

If you are going to buy and own expensive shares, you must be very confident that high rates of growth can continue for a long time into the future.   Since no one can predict the future accurately, you need to protect yourself by not paying too high a price for shares.

Knowing how to value shares and understanding the crucial relationship between cash profits and interest rates are important.  Know how much of a company's current share price is based on its current profits and how much is related to future profits growth.  

Though profits growth is important in valuing shares, you should also know how to not pay too much for it.

High share prices can unravel very quickly when profits stop growing.  

Companies which investors like tend to command very high valuations because they are growing turnover and profits rapidly, or are expected to do so   Their shares will have very high multiples of profits and cash flows and very low yield attached to them.  

This can persist for a long time but the dangers for investors of owning expensive or highly-rated shares can be significant when profits stop growing.  

Investors in these shares may often lose a large amount of their investment and learned a brutal lesson of the high risks of owning expensive or highly-rated shares.  This experience has been repeated countless times in the past and will surely happen many times again int he future.

• Using owner earnings to value shares: Setting a ma...
• Using owner earnings to value shares: Earnings Pow...
• Using owner earnings to value shares: Cash yield ...

Growth Stocks

How to select growth stocks?

Selecting growth stocks can be a challenging task, but there are a few key factors to consider when evaluating potential investments. Here are a few strategies that may help you identify growth stocks:

Look for companies with strong revenue and earnings growth: Companies that have consistently grown their revenues and earnings over time are more likely to continue growing in the future. Look for companies with strong revenue and earnings growth rates, and compare them to industry averages.

Look for companies with a competitive advantage: Companies that have a sustainable competitive advantage, such as a strong brand, proprietary technology, or a large market share, are more likely to continue growing in the future.

Look for companies with a solid management team: A strong management team is essential for a company's long-term growth. Look for companies with a track record of success and a clear vision for the future.

Look for companies in growing industries: Companies that operate in growing industries, such as technology, healthcare, or renewable energy, are more likely to benefit from long-term growth trends in those industries.

Look at valuation metrics: Growth stocks tend to trade at higher valuations than value stocks, so it's important to consider a company's price-to-earnings (P/E) ratio, price-to-sales (P/S) ratio, and other valuation metrics to ensure that you are getting a good deal.

Do your own research: It's important to conduct thorough research on the companies you are considering investing in. Look at their financial statements, management team, and industry trends to identify companies with strong fundamentals and growth potential.

It's worth noting that past performance is not a guarantee of future results and that investing in the stock market carries risk. It's always good to do your own research, invest in a diverse set of assets, and have a well-defined investment strategy that aligns with your financial goals.

What are the risks of investing in growth stocks?

Investing in growth stocks can be a great way to achieve strong returns, but it also comes with certain risks. Here are a few of the risks to consider when investing in growth stocks:

High Valuation Risk: Growth stocks tend to trade at higher valuations than value stocks, so there's a risk that the stock's price may not be justified by the company's fundamentals. High valuation can lead to a stock to be overpriced and may result in disappointment in future returns.

Earnings Risk: Growth stocks often have high expectations for earnings growth, which means that if a company misses its earnings estimates, its stock price may drop. This can be especially true for companies that have high P/E ratios.

Industry Risk: Companies that operate in a specific industry are subject to the risks of that industry. For example, companies in the technology sector are subject to rapid technological change, while companies in the healthcare sector may be subject to changes in government regulations.

Interest rate Risk: Growth stocks are sensitive to changes in interest rates, as they are more reliant on future earnings than current dividends. When interest rates rise, the value of future earnings may decrease, causing the stock price to fall.

Concentration Risk: Investing in a small number of growth stocks can lead to concentration risk, which means that if one of the stocks in your portfolio performs poorly, it can have a significant impact on your overall returns.

Political and Economic Risk: Political and economic events such as war, natural disasters, and changes in government policies can also impact a growth stock's performance.

It's important to keep in mind that investing in growth stocks carries a higher level of risk than investing in value stocks. It's important to diversify your portfolio, do your own research and have a well-defined investment strategy that aligns with your financial goals and risk tolerance.

Growth Stocks: Searching for the Sprinters

Growth Stocks: Searching for the Sprinters

by Douglas Gerlach

Investors who focus on growth try to predict which companies will grow faster in the future -- faster than the rest of the stocks in the market, or faster than other stocks in the same industry. If you're successful in buying a company that does grow faster than other companies, then it's likely that the price of that company's stock will increase as well, and you can make a profit.
(My comment: Provided you did not pay too high a price to buy it.)

The stock of a company that grows its earnings and revenues faster than average is known as a growth stock. These companies usually pay few or no dividends, since they prefer to reinvest their profits in their business.

Peter Lynch primarily used a growth stock approach in managing the Magellan mutual fund. Individuals who invest in growth stocks often prefer it because their portfolio will be made up of established, well-managed companies that can be held onto for many years. Companies like Coca-Cola, IBM, and Microsoft have demonstrated great growth over the years, and are the cornerstones of many portfolios. Most investment clubs stick to growth stocks as well.

GROWTH STOCK APPROACH

Every investor would like to select a list of securities that will do better than the average over period of years.

A growth stock may be defined as one which has done this in the past and is expected to do so in the future.

[A company with an ordinary record cannot be called a growth company or a "growth stock" merely because its proponent expects it to do better than the average in the future.  It is just a "promising company."]

It seems only logical that the intelligent investor should concentrate upon the selection of growth stocks.

It is mere statistical chore to identify companies that have "outperformed the averages" in the past.

However, investing successfully in them is more complicated.



Two Catches of Growth Stock Investing

Two catches to watch out for in growth investing.

1.  The common stocks with good records and apparently good prospects sell at correspondingly high prices. 

• The investor may be right in his judgement of their prospects and still not fare particularly well, merely because he has paid in full (and perhaps overpaid) for the expected prosperity.

2.  His judgement as to the future may prove wrong. 

• Unusually rapid growth cannot keep up forever; when a company has already registered a brilliant expansion, its very increase in size makes a repetition of its achievement very difficult.  
• At some point the growth curve flattens out, and in many cases it turns downward.

Naturally, the purchase at a time when popular growth stocks were most favoured and active in the market would have had disastrous consequences.

• They were too obvious a choice.  
• Their future was already being paid for in the price.  
• Popular growth stocks may have failed to continue their progress and have even reported downright disappointing results.

How can your investment into growth stocks be protected?

Presumably, it is the function of intelligent investment to overcome these hazards by the exercise of sound judgement and skillful selection.

This is the natural and appropriate endeavour for the enterprising investor.

Benjamin Graham regrets that he has little concrete guidance to offer the enterprising investor in this field.

The exercise of specialized foresight, the weighing of future probabilities and possibilities are not to be learned out of books - nor can they be aided much by suggested rules and techniques.

Elaborate study of the life cycle of industries and discussing a number of "symptoms of decay"; by noticing of which the alert investor may escape out of a once expanding industry before it is too late.

These suggested techniques require more ability and application than most investors can bring to bear on the problem.

[It is debatable whether once an industry has turned downward, it will never recover and that all securities within it must be permanently avoided.]



More guidance on Growth Stock Investing

The stock of a growing company, if purchasable at a suitable price, is obviously preferable to others.

No matter how enthusiastic the investor may feel about the prospects of a particular company, however, he should set a limit upon the price that he is willing to pay for such prospects.

• Such a rule would result at times in the missing of an unusually good opportunity. 
• More often, it would mean the investor's saving himself from "going overboard" on an issue that looked especially good to him and everyone else and consequently was selling much too high.

An illustration of investing in growth stocks

Two highly successful enterprises and both were considered to have excellent prospects of long-term growth.  Both were priced at 22 times that year's earnings.  The average price of Company A in 1939 was 62 and the price of company B in 1939 was 42.  The ordinary investor was as likely to buy one issue as the other.

Company A 's earnings had risen from $2.9 per share in 1939 to $10.90 per share in 1947.  Its price was equivalent to 150 or much more than double its 1939 average.  In the same years, the profits of Company B had moved up from $1.89 to $2.13, in spite of the record prosperity of 1947 and its price had fallen from 42 to 29.


                       Company A        Company B               Company C
                       1939    1947       1939   1947               1939    1947

Price               62         150         42       29                        6      26
Earnings        2.9         10.9      1.89    2.13                  0.13     3.14
P/E                 22                        22


The choice between the attractive issue that turns out well and the one that does poorly is by no means easy to make in the growth-stock field.


At the same time, it might be interesting to add a third pharmaceutical Company C which was by no means well regarded in 1939 - for its average price was only 6 (as against 28 in 1929) and it paid no dividend.  On its past record it could not qualify at all as a growth issue.  Yet in 1947 its earnings were $3.14 per share as against only 13 cents in 1939, and its April price in 1948 had risen to 26 - a much better percentage gain than CompanyA's.

The best opportunity in the field of drug stocks turned out to be where it was least expected - an all too frequent happening.


Inferences from the above illustration for investing in Growth Stocks

• Superior results may be obtained in this field if the choices are competently made.
• Even with careful selection, some of the individual issues may fare relatively poorly.  Some may actually decline and others may have only slight advances
• Thus for good results in the growth stock field there is need not only for skillful analysis but for ample diversification as well.

Summary on investing in Growth Stocks

1. The enterprising investor may properly buy growth stocks.
2. He should beware of paying excessively for them.  He might well limit the price by some practical rule.
3. A growth stock program will not be automatically successful; its outcome will depend on the foresight and judgement of the investor or his advisors rather than on any  clear-cut methods of analysis.

Price to Book Value Ratio

Price to Book Ratio

P/BV ratio
= Market price of common stock / Book Value per share

Unless the market becomes grossly overvalued (1999 and 2000), most stocks are likely to trade at multiples of less than 3 to 5 times their book value.

There is usually little justification for abnormally high price to book value ratios - except perhaps for firms that have abnormally low levels of equity in their capital structures.

Other than that, high P/BV multiples are almost always caused by "excess exuberance."

As a rule, when stocks start trading at 7 or 8 times their book values, or more, they are becoming overvalued.




Investor Mistakes (Short-lived Growth)

So called value stocks are stocks that have low price to book ratios, and growth stocks are stocks that have relatively high price to book ratios.

Many studies demonstrate that value stocks outperform growth stocks, perhaps because investors overestimate the odds that a firm that has grown rapidly in the past will continue to do so (Short-lived Growth).

DCF analysis is the most popular valuation methodology today. Growth (or lack of it) is an integral to a valuation exercise.

Discounted Cash Flow analysis to determine Intrinsic Value

The value of a business, a share of stock, or any other productive asset is the present value of its future cash flows.

Discounted cash flow (DCF) analysis (intrinsic value principle of John Burr Williams) is the most popular valuation methodology today.

Its popularity, however, hides the important reality that value is easier to define than to measure (easier said than done).

The tools Graham (margin of safety principle) and Fisher (business franchise principle) developed remain crucial in this exercise.



Value stocks versus Growth stocks:  this distinction has limited difference.

One hazard of undue reliance on DCF analysis is a temptation to classify stocks as either value stocks or growth stocks.  It is a distinction with limited difference.

Value a business (or any productive asset) requires estimating its probable future performance and discounting the results to present value.

The probable future performance includes whatever growth (or shrinkage) is assumed.

So growth (or lack of it) is integral to a valuation exercise.

Investing is the deliberate determination that one pays a price lower than the value being obtained.

Only speculators pay a price hoping that through growth the value rises above it.



Conventional Value Investing = low P/E, low P/BV and high DY companies

Value investing is conventionally defined as buying companies bearing low ratios of price-to-earnings, price-to-book value, or high dividend yields.

But these metrics do not by themselves make a company a value investment.  It is not that simple.

Nor does the absence of such metrics prevent an investment from bearing a sufficient margin of safety and qualitative virtues to justify its inclusion in a value investor's portfolio.




Growth doesn't equate directly with value either.

Growing earnings can mean growing value.

But growing earnings can also mean growing expenses, and sometimes expenses growing faster than revenues.

Growth adds value only when the payoff from growth (revenue) is greater than the cost of growth (expenses).

A company reinvesting a dollar of earnings to grow by 99 cents is not helping its shareholders and is not a value stock, though it may be a growth stock.




Read also:

Value Vs Growth

http://klse.i3investor.com/blogs/kcchongnz/45456.jsp

What drives the return of your stock investment, Growth or Value?

http://klse.i3investor.com/blogs/kcchongnz/81690.jsp

“In our opinion, the two approaches (value and growth) are joined at the hip: Growth is always a component in the calculation of value, constituting a variable whose importance can range from negligible to enormous and whose impact can be negative as well as positive…In addition, we think the very term “value investing” is redundant. What is “investing” if it is not the act of seeking value at least sufficient to justify the amount paid?”      Warren Buffett Letters to investor, 1992.