FAST GROWERS
Traits
• Small, aggressive new companies. Growing
at 20-25%.
• Land of the 10-40x, even 200x. 1-2 such
companies can make a career.
• Lousy Industry
o May not belong to fast growing industry.
Can expand in the room in a slow growth
industry by taking market share.
o Depressed industries are likely places to
find potential bargains. If business
improves from lousy to mediocre, you are
rewarded, rewarded again when mediocre
turns to good, and good to excellent.
o Moderately fast growers (20-25%) in slow
growth industries are ideal investments.
Look for companies with niches that can
capture market share without price
competition. In business, competition is
never as healthy as total domination.
o Growth ≠ Expansion, leading people to
overlook great companies like Phillip
Morris. Industry wide cigarette
consumption may decline, but company
can increase earnings by cost cuts and
price increases. Earnings growth is the
only growth that really counts. If costs
rise 4%, but prices rise 6%, and profit
margin is 10%, then extra 2% price rise
= 20% increase in earnings.
o Greatest companies in lousy industries
share certain characteristics:
i) low cost operators / penny pinchers
in the executive suite
ii) avoid leverage
iii) reject corporate hierarchies
iv) workers are well paid and have a
stake in the company’s future
v) they find niches, parts of the market
that bigger companies overlook. Zero
Growth Industry = Zero Competition.
• Hot Industry
o Hot Stocks + Hot Industry = Greater
Competition. Companies can thrive only
due to niche/moat/patents etc.
o Growth ≠ Expansion. In low growth
industries, companies expand by
capturing market share, cutting costs
and raising prices. When an industry
gets too popular, nobody makes money
there anymore.
• Life Phases of a Fast Grower: each may last
several years. Keep checking earnings,
growth, stores to check aura of prosperity.
Ask, what will keep earnings going?
i) Startup phase: companies work out
kinks in the basic business. Riskiest
phase for the investor because success is
not yet established.
ii) Rapid Expansion: company enters new
markets. Safest phase for investor where
most amount of money is made, because
growth is merely an act of duplication
across markets. Company reinvests all
FCF into expansion. No dividends help
faster expansion. IPO helps in expanding
without bank debt / leverage.
iii) Maturity / Saturation: company faces the
fact that there’s no easy way to continue
expansion. Most problematic phase
because company runs into its own
limitations. Other ways must be found to
increase earnings, possibly only, via
luring customers away from competitors.
If M&A / diworseification follows, then
you know management is confused.
• Find out growth plans and check if plan is
working?
i) Cost cuts – the proof is in decrease of
selling and administrative costs.
ii) Raise prices
iii) Entry into new markets
iv) Sell more volume in existing markets
v) Exit loss making operations
• What continues to triumph, vs, flop, is:
i) Capable management
ii) Adequate financing
iii) Methodical approach to expansion – slow
but steady wins this kind of race.
o When a company tries to open >100
stores/year, it’s likely to run into
problems. In its rush to glory, it can
pick the wrong sites or managers, pay
too much for real estate, and, fail to
properly train employees. It is easier
to add 35-40 stores / year.
• Re-classification away from Fast Grower
o A large fast growth company faces
devaluation risk, since growth may slow
down as it runs out of space for further
expansion.
o Inability to maintain double digit growth
may see a re-classification into a Slow
Grower, Cyclical or Stalwart. High fliers
of one decade are groundhogs of the next.
o Fast Growers like hotels/retail having
prime real estate turn into Asset Plays.
o There’s high risk, especially in younger
companies that are overzealous and
underfunded. The headache of
underfinancing may lead to bankruptcy.
o Fast Grower’s that can’t stand prosperity,
diworseify, fall out of favour, and, turn
into Turnaround candidates.
o Every Fast Grower turns into a Slow
Grower, fooling many people. People have
a tendency to think that things won’t
change, but eventually they do,
o Very few companies switch from being a
Slow Grower to a Fast Grower.
o Companies may fall into 2 categories at
the same time, or, pass through all
categories over time (Disney).
• During 1949-1995, an investment in the 50
growth stocks on Safian’s Growth Index
returned 230x, while the Safian Cyclical
Index only returned 19x.
• Growth companies were the star performers
during and after 2 corrections (1981-82 and
1987), and they held their own in the 1990
Saddam selloff. The only time you wished
you didn’t own them was 197374, when
growth stocks were grossly overpriced.
Buying and Holding Tips
• Fast Grower => 2x GNP growth rate.
Sustaining 30% growth rate is very difficult,
even for 3 years. 20-25% growth rate is more
sustainable (investing sweet spot).
• Best place to find a 10x stock is close to
home – if not the backyard, then in the
kitchen, mall, workplace etc. You’ll find a
likely prospect ~2/3 times a year. The
person with the edge is always in a position
to outguess the person without an edge.
• Long shots almost never pay off. Better to
miss the 1st stock move (during phase I), or
even the late stage of phase I, when the
company’s only reached 5-10% of market
saturation, and wait to see if it’s plans are
working. If you wait, you may never need to
buy, since failure would’ve become visible.
• Does the idea work elsewhere? Must prove
that cloning works in other markets, and
show its ability to survive early mistakes,
limited capital, find required skilled labour.
• The most fascinating part of long term, Fast
Growers is how much time you have to catch
them. Even a decade later and with stock
already up 20x, it’s not too late to capitalize
on an idea that has still not run its course.
• Emerging growth stocks are much more
volatile than larger companies, dropping and
soaring like sparrow hawks around the
stable flight of buzzards. After small caps
have taken one of these extended dives, they
eventually catch upto the buzzards.
• Small Company Index PE / S&P 500 PE:
Since small companies are expected to grow
faster than larger ones, they’re expected to
sell at higher PE’s, theoretically. In practice,
this isn’t always the case. During periods
when Emerging Growth is unpopular with
investors, these small caps get so cheap that
their PE = S&P 500 PE. When wildly popular
and bid up to unreasonably high levels, it is
= 2x S&P 500 PE.
• In such cases, small caps may get clobbered
for several years afterward. Best time to buy
is when Small PE / Large PE < 1.2x. To reap
the reward from this strategy, you’ve to be
patient. The rallies in small cap stocks can
take a couple of years to gather storm and
then several more years to develop.
• A similar pattern applies to the Growth vs
Value pots. Be patient. Watched stock never
boils. When in doubt, tune in later.
• Look for a good balance sheet and large
profits. Trick is in figuring out when the
growth stops and how much to pay for it?
• Recent price run-ups shouldn’t matter, so
long as PEG still makes it attractive.
• If PEG =1x, then 20% growth @ 20x PE is >
10% growth @ 10x PE. Higher compounded
earnings will compensate even for PE
multiple shrinkage.
• High PE leaves little room for error. Best way
to handle a situation where you love the
company but not the price (great company,
high growth, but high PE), is to make a
small commitment and then increase it in
the next selloff. One can never predict how
far the price may fall. Even if you buy after a
setback, be prepared for further declines
when you might consider buying even more
shares. If the story is still good, after review,
then you’re happy that the price fell.
• So, the important issue is why has the stock
fallen so much? If the long term story is still
intact and the growth will continue for a
long time, then buy more. If you can place
the company in its attractive, mid-life phase,
ex. 2nd decade of 30 years of growth, then
you shouldn’t mind paying 20x PE for a 20-
25% growth rate, especially if market PE =
18-20x with an 8-10% growth rate.
• If you sell at 2x, you won’t get 10x. As long
as same store sales are rising, company isn’t
crippled with excess debt, and is following
its stated expansion plans, stick around. If
the original story stays intact, you’ll be
amazed at the results in several years.
• Trick is to not lose a potential 10x, but know
that, if earnings shrink, then so will the PE
that’s been bid up high – double whammy.
• It’s harder to stick with a winning stock after
price increases, vs, continuing to believe in a
company after price falls. If you’re in danger
of being faked out into selling, revisit the
reasons / story, as to why you bought it in
the first place. There are 2 ways investors
can fake themselves out of the big returns
that come from great growth companies.
i) Waiting to buy the stock when it looks
cheap: Throughout its 27-year rise from
a split-adjusted 1.6 cents to $23, WalMart
never looked cheap compared to
the market. Its PE rarely dropped <20x,
but earnings were growing at 25-30%
Any business that keeps up a 20-25%
growth rate for 20 years rewards its
owners with a massive return even if the
overall market is lower after 20 years.
ii) Underestimating how long a great
growth company can keep up the pace.
These "nowhere to grow" theories come
up often & should be viewed sceptically.
o Don't believe them until you check
for yourself. Look carefully at where
the company does business and at
how much growing room is left.
Whether or not it has growing room
may have nothing to do with its age.
o Wal-Mart IPO’d in 1970. By 1980 =
stock 20x, with 7x number of stores.
Was it time to sell, not be greedy, &
put money elsewhere? Stocks don’t
care who owns it and questions of
greed are best resolved in church,
not in brokerage accounts.
o The important issue to analyze was
not whether the Wal-Mart stock
would punish its holders, but
whether the company had saturated
the market. The answer was No.
Wal-Mart’s reach was only 15% of
USA. Over the next 11 years, the
stock went up another 50x.
the market. Its PE rarely dropped <20x,
but earnings were growing at 25-30%
Any business that keeps up a 20-25%
growth rate for 20 years rewards its
owners with a massive return even if the
overall market is lower after 20 years.
ii) Underestimating how long a great
growth company can keep up the pace.
These "nowhere to grow" theories come
up often & should be viewed sceptically.
o Don't believe them until you check
for yourself. Look carefully at where
the company does business and at
how much growing room is left.
Whether or not it has growing room
may have nothing to do with its age.
o Wal-Mart IPO’d in 1970. By 1980 =
stock 20x, with 7x number of stores.
Was it time to sell, not be greedy, &
put money elsewhere? Stocks don’t
care who owns it and questions of
greed are best resolved in church,
not in brokerage accounts.
o The important issue to analyze was
not whether the Wal-Mart stock
would punish its holders, but
whether the company had saturated
the market. The answer was No.
Wal-Mart’s reach was only 15% of
USA. Over the next 11 years, the
stock went up another 50x.
Sell When
• Hold as long as earnings are growing,
expansion continues and no impediments
arise. Check the story every few months as if
you’re hearing it for the very first time.
• If a Fast Grower rises 50% and the story
starts sounding dubious, sell and rotate into
another, where the current price is <= your
purchase price, but the story sounds better.
• Main thing to watch is the end of phase II of
rapid expansion. Company has no new
stores, old stores are shabby, and the stock
is out of fashion.
• Wall Street covers the stock widely,
institutions hold 60%, and 3 national
magazines fawn over the CEO.
• Large companies with 50x PE!? Even at 40x,
and with wide, saturated presence, where
will the large company grow?
• Last quarter same-store sales are down 3%,
new store sales are disappointing, and the
company is telling positive stories, vs,
showing positive results.
• Top executives / employees leave to join a
rival.
• PE = 30x, but next 2 years’ growth rate =
15%. Therefore, PEG = 2x (very negative)
Examples
• Annheuser Busch, Marriott, Taco Bell,
Walmart, Gap, AMD, Texas Instruments,
Holiday Inn, carpets, plastics, retail,
calculators, disk drives, health maintenance,
computers, restaurants
• While it’s possible to make 2-5x in Cyclicals
and Undervalued situations (if all goes well),
payoffs in Fast Growers like restaurants and
retailers are bigger. Restaurants/retailers
can expand across the country and keep up
the growth rate at 20% for 10-15 years.
• Not only do they grow as fast as high tech
companies, but unlike an electronics or shoe
company, restaurants are protected from
competition. Competition is slower to arrive
and you can see it coming. A restaurant
chain takes a long time to work its way
across the country and no foreign company
can service local customers.
• Taste homogeneity helps scale in food,
drinks, entertainment, makeup, fashion etc.
Popularity in 1 mall = popularity in another.
Certain brands prosper at else’s expense.
• Ways to increase earnings (restaurants):
i) Add more locations
ii) Improve existing operations
iii) High turnover with low priced meals
iv) High priced meals with lower turnover
v) High OPM because of food made with
cheaper ingredients, or, due to low
operating costs
• To break even, a restaurants’ sales must =
Capital Employed. Restaurant group as a
whole may only grow slowly at 4%, but as
long as Americans eat >50% of their meals
out of home, there’ll be new 20x stocks.
People Examples
• Higher failure rate than Stalwarts, but if and
when one succeeds, it may boost income 10-
20-100x.
• Actors, real estate developers, musicians,
small businessmen, athletes, criminals
PE Ratio
• Highest for Fast Growers at 14-20x.
Company with a High PE must have
incredible growth (for next 2 years) to justify
its price. It’s a miracle for even a small
company to justify a 50x PE, as may so
happen during a bull market.
• 1 year forward PE of 40x = dangerously high
and in most cases extravagant. Even fastest
growing companies can rarely achieve 25%
growth, and 40% is a rarity. Such frenetic
growth isn’t sustainable for long & growing
too fast tends to lead to self destruction.
• 40x PE @ 30% growth isn’t attractive, but
not bad if S&P 500 = 23x PE & Coke PEG =
2x (PE = 30x @ 15% growth).
• Unlike Cyclical where the PE contracts near
the end of the cycle, Fast grower’s PE gets
bigger and may reach absurd, illogical levels.
• Earnings are not constant and PE of 40x vs
3x shows investor willingness to gamble on
higher earnings, vs, scepticism about the
cheaply priced company’s future.
PEG
2 Minute Drill
• Where and how can the company continue
to grow fast?
• La Quinta Motels started in Texas. Company
successfully duplicated its formula in
Arkansas & Louisiana. Last year it added
28% more units. Earnings have increased
every quarter. Plans rapid future expansion
& debt isn’t excessive. Motels are low growth
industry and very competitive but La Quinta
has found something of a niche. Long way to
go before it saturates the market.
• Where and how can the company continue
to grow fast?
• La Quinta Motels started in Texas. Company
successfully duplicated its formula in
Arkansas & Louisiana. Last year it added
28% more units. Earnings have increased
every quarter. Plans rapid future expansion
& debt isn’t excessive. Motels are low growth
industry and very competitive but La Quinta
has found something of a niche. Long way to
go before it saturates the market.
Checklist
• Percentage of sales – is a new fast growing
product a large % of sales?
• Recent growth rate – favour 20-25% growth
rates. Be wary if growth is > 25%. Hot
industries show growth >50%.
• Proof – has company duplicated its success
in >1 city, for planned expansion to work?
• Runway – does it still have room to grow?
• PE – is it high or low, vs, growth rate?
• Δ Growth rate – is expansion speeding up or
slowing down? For companies doing sales
via large, single deals, vs, selling high
volume & low ticket items, growth slowdown
can be devastating because doing more
volume at bigger ticket sizes is difficult.
When growth slows, stock drops
dramatically.
• Institutional ownership / Analyst coverage –
no presence is a positive, as growth
expectations are still not captured in the
Price or PE.
Portfolio Allocation %
• 30-40% Allocation in Magellan. Magellan’s
allocation to Fast Growers was never >50%.
• 40% in Personal investor’s 10 stock portfolio
• If looking for 10x stocks, likelihood increases
as you hold more stocks. Among several, the
one that actually goes the farthest maybe a
surprise. The story may start at a certain
point, with specific expectations, and get
progressively better. There’s no way to
anticipate pleasant surprises.
• More stocks provide greater flexibility for
fund rotation. If something happens to a
secondary company, it may get promoted to
being a primary selection.
Risk/Reward
• High Risk – High Gain. Higher potential
upside = Greater potential downside.
• +10x / (-100%)
• Major bankruptcy risk for small fast grower’s
via underfinanced, overzealous expansion
• Major rapid devaluation risk for large fast
growers once growth falters, because there’s
no room left for future expansion
The Peter Lynch Playbook
Twitter@mjbaldbard 10 mayur.jain1@gmail.com
Twitter@mjbaldbard 10 mayur.jain1@gmail.com
