Many factors can derail any business forecast.

Forecasting future growth is considerably imprecise

Forecasting sales or profits many years into the future is considerably more imprecise, and a great many factors can derail any business forecast. 

There are many investors who make decisions solely on the basis of their own forecasts of future growth. After all, the faster the earnings or cash flow of a business is growing, the greater that business’s present value. 

Difficulties confronting growth-oriented investors

Yet several difficulties confront growth-oriented investors. 

• First, such investors frequently demonstrate higher confidence in their ability to predict the future than is warranted. 
• Second, for fast-growing businesses even small differences in one’s estimate of annual growth rates can have a tremendous impact on valuation.  
• Moreover, with so many investors attempting to buy stock in growth companies, the prices of the consensus choices may reach levels unsupported by fundamentals. 
• Investors may at times be lured into making overly optimistic projections based on temporarily robust results, thereby causing them to overpay for mediocre businesses. 
• When growth is anticipated and therefore already discounted in securities prices, shortfalls will disappoint investors and result in share price declines.

When a good business can become a bad investment

 As Warren Buffett has said, “For the investor, a too-high purchase price for the stock of an excellent company can undo the effects of a subsequent decade of favorable business developments.” 

Growth investors tend to oversimplify growth into a single number

Another difficulty with investing based on growth is that while investors tend to oversimplify growth into a single number, growth is, in fact, comprised of numerous moving parts which vary in their predictability. 

Sources of earnings growth

For any particular business, for example, earnings growth can stem from increased unit sales related 

• to predictable increases in the general population, 
• to increased usage of a product by consumers, 
• to increased market share, 
• to greater penetration of a product into the population, or 
• to price increases. 

Specifically, a brewer might expect to sell more beer as the drinking-age population grows but would aspire to selling more beer per capita as well. Budweiser would hope to increase market share relative to Miller. The brewing industry might wish to convert whiskey drinkers into beer drinkers or reach the abstemious segment of the population with a brand of nonalcoholic beer. Over time companies would seek to increase price to the extent that it would be expected to result in increased profits. 

Some of these sources of earnings growth are more predictable than others. 

• Growth tied to population increases is considerably more certain than growth stemming from changes in consumer behavior, such as the conversion of whiskey drinkers to beer. 
• The reaction of customers to price increases is always uncertain. 

On the whole it is far easier to identify the possible sources of growth for a business than to forecast how much growth will actually materialize and how it will affect profits. 

Rapid growth can lead to big returns .... or painful mistakes. Be knowledgeable.

Growth is a strategy in which stock pickers may have a better chance of success.

Buying growth with a broad-brushed index approach is a formula for underperformance, but some smart choices can lead to outperformance.


Value companies

A good value investment will rise in price because the market will eventually take notice of it - either because people become more widely aware of its performance or because they recognise that its problems are being corrected.

As the market corrects its earlier impressions, the stock rises, sometimes dramatically.

If it is to continue to rise, however, the company has to do more than show it is worthy of recognition.  It has to perform ... and grow.

Some "value" investments actually have great growth potential, while many will at best turn in tepid growth even if all goes well.


Growth companies

The best growth companies, however, will achieve phenomenal expansion.

And the very best can keep it up for years, letting you grow wealth while deferring taxes.

That kind of long-term, high growth is what creates 20-baggers an even 100-baggers.

A single investment like that can transform your portfolio - your whole financial future, in fact.

And you are unlikely to find such a company without identifying extraordinary growth potential.

These businesses aren't just looking to succeed in an established industry.  They want to shake things up.



Two Catches

1.  Rapid growth usually doesn't last long.

Some companies mange to grow sales at an exponential rate (over 100%) for a year, maybe even several.  But maintaining that pace eventually becomes impossible.

If they are successful, companies naturally mature to a state of slow growth.

They evolve into the kind of large, steady companies that offer steady, but usually not large, returns.

Using a growth strategy means finding companies that can sustain extraordinary growth longer than the market realises and expects, either because you have caught it early in its growth cycle, or because it has such strong structural advantages that it maintains a dominant position in its industry.


2.  The market tries to anticipate the future.

You may have heard about companies being "priced" for future events, including an expectation that future earnings will be a lot better than the ones you see today.

Sometimes predictions are too rosy; sometimes they underestimate what a company can do.

When they are too optimistic, high-priced stocks crash down to earth.

When they are too cautious, an "expensive" stock can keep rising sometimes for years.

We want to find the latter.




Comments:

If you own equal amount of ten stocks and one drops 50%, your portfolio goes down 5%.

If you own equal amount of ten stocks and one goes up 500%, your whole portfolio increases in value by 50%.  From just ONE stock.

You can apply that logic on whatever scale you like - a concentrated portfolio of just a few stocks or a less-volatile portfolio of 100 stocks.

With diligence, patience and the right approach, you will find stocks that go up 500% or more.

Of course, you will also pick some that go down 90%.

But is it not true that value stocks beat growth stocks?  Yes, they do  ... broadly speaking.  Unless, that is, you pick the right growth companies.

These rapid growth companies are a part of your broader approach to wealth creation.

Philip Fisher’s Investment Philosophy

•Philip Fisher’s Investment Philosophy

•Introduction

•The late Phil Fisher was one of the great investors of all time and the author of the classic book Common Stocks and Uncommon Profits.

•Introduction

•Fisher started his money management firm, Fisher & Co., in 1931 and over the next seven decades made tremendous amounts of money for his clients.

•Introduction

•For example, he was an early investor in semiconductor giant Texas Instruments TXN.

•Fisher also purchased Motorola MOT in 1955, and in a testament to long-term investing, held the stock until his death in 2004.

•Introduction

•"Common Stocks and Uncommon Profits" - is a MUST READ!

•Fisher's Investment Philosophy

•Fisher's investment philosophy can be summarized in a single sentence: Purchase and hold for the long term a concentrated portfolio of outstanding companies with compelling growth prospects that you understand very well.

•Fisher's Investment Philosophy

•This sentence is clear on its face, but let us parse it carefully to understand the advantages of Fisher's approach.

•Fisher's Investment Philosophy

•The question that every investor faces is, of course, WHAT to buy? - and - WHEN to buy it?

•Fisher's answer is to purchase the shares of superbly managed growth companies, and he devoted an entire chapter in Common Stocks and Uncommon Profits to this topic.

•Fisher's Investment Philosophy

•The chapter begins with a comparison of "statistical bargains," or stocks that appear cheap based solely on accounting figures, and growth stocks, or stocks with excellent growth prospects based on an intelligent appraisal of the underlying business's characteristics.

•Fisher’s Investment Philosophy –
The Problem with Statistical Bargains

•The problem with statistical bargains, Fisher noted, is that while there may be some genuine bargains to be found, in many cases the businesses face daunting headwinds that cannot be discerned from accounting figures, such that in a few years the current "bargain" prices will have proved to be very high.

•Fisher’s Investment Philosophy –
The Problem with Statistical Bargains

•Furthermore, Fisher stated that over a period of many years, a well-selected growth stock will substantially outperform a statistical bargain.

•Fisher’s Investment Philosophy –
The Problem with Statistical Bargains

•The reason for this disparity, Fisher wrote, is that a growth stock, whose intrinsic value grows steadily over time, will tend to appreciate "hundreds of per cent each decade," while it is unusual for a statistical bargain to be "as much as 50 per cent undervalued.”

•Fisher’s Investment Philosophy – The Universe of Growth Stocks

•Fisher divided the universe of growth stocks into large and small companies.

•Fisher’s Investment Philosophy – The Universe of Growth Stocks

•On one end of the spectrum are large financially strong companies with solid growth prospects.

•At the time, these included IBM (IBM), Dow Chemical (DOW), and DuPont (DD), all of which increased fivefold in the 10-year period from 1946 to 1956.

•Fisher’s Investment Philosophy – The Universe of Growth Stocks

•Although such returns are quite satisfactory, the real home runs are to be found in "small and frequently young companies... [with] products that might bring a sensational future.”

•Fisher’s Investment Philosophy – The Universe of Growth Stocks

•Of these companies, Fisher wrote, "the young growth stock offers by far the greatest possibility of gain.

•Sometimes this can mount up to several thousand per cent in a decade.”

•Fisher’s Investment Philosophy – The Universe of Growth Stocks

•Fisher's answer to the question of what to buy is clear:

•All else equal, investors with the time and inclination should concentrate their efforts on uncovering young companies with outstanding growth prospects.

•Fisher’s Investment Philosophy – The Universe of Growth Stocks

•Remember - much has changed - therefore YOU must integrate "today's" Economics and Financial Markets in with Mr. Fisher's Philosophy!

•Fisher's 15 Points

•All good principles are timeless, and Fisher's famous "Fifteen Points to Look for in a Common Stock" from Common Stocks and Uncommon Profits remain as relevant today as when they were first published.

•Fisher's 15 Points

•The 15 points are a qualitative guide to finding superbly managed companies with excellent growth prospects.

•According to Fisher, a company must qualify on most of these 15 points to be considered a worthwhile investment:

•Fisher's 15 Points

•1. Does the company have products or services with sufficient market potential to make possible a sizable increase in sales for at least several years?

•A company seeking a sustained period of spectacular growth must have products that address large and expanding markets.

•Fisher's 15 Points

•2. Does the management have a determination to continue to develop products or processes that will still further increase total sales potentials when the growth potentials of currently attractive product lines have largely been exploited?

•All markets eventually mature, and to maintain above-average growth over a period of decades, a company must continually develop new products to either expand existing markets or enter new ones.

•Fisher's 15 Points

•3. How effective are the company's research-and-development efforts in relation to its size?

•To develop new products, a company's research-and-development (R&D) effort must be both efficient and effective.

•Fisher's 15 Points

•4. Does the company have an above-average sales organization?

•Fisher wrote that in a competitive environment, few products or services are so compelling that they will sell to their maximum potential without expert merchandising.

•Fisher's 15 Points

•5. Does the company have a worthwhile profit margin?

•Berkshire Hathaway's (BRK.B) vice-chairman Charlie Munger is fond of saying that if something is not worth doing, it is not worth doing well. Similarly, a company can show tremendous growth, but the growth must bring worthwhile profits to reward investors.

•Fisher's 15 Points

•6. What is the company doing to maintain or improve profit margins?

•Fisher stated, "It is not the profit margin of the past but those of the future that are basically important to the investor." Because inflation increases a company's expenses and competitors will pressure profit margins, you should pay attention to a company's strategy for reducing costs and improving profit margins over the long haul. This is where the moat framework can be a big help.

•Fisher's 15 Points

•7. Does the company have outstanding labor and personnel relations?

•According to Fisher, a company with good labor relations tends to be more profitable than one with mediocre relations because happy employees are likely to be more productive. There is no single yardstick to measure the state of a company's labor relations, but there are a few items investors should investigate. First, companies with good labor relations usually make every effort to settle employee grievances quickly. In addition, a company that makes above-average profits, even while paying above-average wages to its employees is likely to have good labor relations. Finally, investors should pay attention to the attitude of top management toward employees.

•Fisher's 15 Points

•8. Does the company have outstanding executive relations?

•Just as having good employee relations is important, a company must also cultivate the right atmosphere in its executive suite. Fisher noted that in companies where the founding family retains control, family members should not be promoted ahead of more able executives. In addition, executive salaries should be at least in line with industry norms. Salaries should also be reviewed regularly so that merited pay increases are given without having to be demanded.

•Fisher's 15 Points

•9. Does the company have depth to its management?

•As a company continues to grow over a span of decades, it is vital that a deep pool of management talent be properly developed. Fisher warned investors to avoid companies where top management is reluctant to delegate significant authority to lower-level managers.

•Fisher's 15 Points

•10. How good are the company's cost analysis and accounting controls?

•A company cannot deliver outstanding results over the long term if it is unable to closely track costs in each step of its operations. Fisher stated that getting a precise handle on a company's cost analysis is difficult, but an investor can discern which companies are exceptionally deficient--these are the companies to avoid.

•Fisher's 15 Points

•11. Are there other aspects of the business, somewhat peculiar to the industry involved, which will give the investor important clues as to how outstanding the company may be in relation to its competition?

•Fisher described this point as a catch-all because the "important clues" will vary widely among industries. The skill with which a retailer, like Wal-Mart (WMT) or Costco (COST), handles its merchandising and inventory is of paramount importance. However, in an industry such as insurance, a completely different set of business factors is important. It is critical for an investor to understand which industry factors determine the success of a company and how that company stacks up in relation to its rivals.

•Fisher's 15 Points

•12. Does the company have a short-range or long-range outlook in regard to profits?

•Fisher argued that investors should take a long-range view, and thus should favor companies that take a long-range view on profits. In addition, companies focused on meeting Wall Street's quarterly earnings estimates may forgo beneficial long-term actions if they cause a short-term hit to earnings. Even worse, management may be tempted to make aggressive accounting assumptions in order to report an acceptable quarterly profit number.

•Fisher's 15 Points

•13. In the foreseeable future will the growth of the company require sufficient equity financing so that the larger number of shares then outstanding will largely cancel the existing stockholders' benefit from this anticipated growth?

•As an investor, you should seek companies with sufficient cash or borrowing capacity to fund growth without diluting the interests of its current owners with follow-on equity offerings.

•Fisher's 15 Points

•14. Does management talk freely to investors about its affairs when things are going well but "clam up" when troubles and disappointments occur?

•Every business, no matter how wonderful, will occasionally face disappointments. Investors should seek out management that reports candidly to shareholders all aspects of the business, good or bad.

•Fisher's 15 Points

•15. Does the company have a management of unquestionable integrity?

•The accounting scandals that led to the bankruptcies of Enron and WorldCom should highlight the importance of investing only with management teams of unquestionable integrity. Investors will be well-served by following Fisher's warning that regardless of how highly a company rates on the other 14 points, "If there is a serious question of the lack of a strong management sense of trusteeship for shareholders, the investor should never seriously consider participating in such an enterprise.”

•Important Don'ts for Investors

•In investing, the actions you don't take are as important as the actions you do take.

•Here is some of Fisher's advice on what you should not do.

•Important Don'ts for Investors

•1. Don't overstress diversification.

•2. Don't follow the crowd.

•3. Don't quibble over eighths and quarters.

•

•

•

•1. Don't overstress diversification.

•Investment advisors and the financial media constantly expound the virtues of diversification with the help of a catchy cliché: "Don't put all your eggs in one basket."

•However, as Fisher noted, once you start putting your eggs in a multitude of baskets, not all of them end up in attractive places, and it becomes difficult to keep track of all your eggs.

•1. Don't overstress diversification.

•Fisher, who owned at most only 30 stocks at any point in his career, had a better solution.

•Spend time thoroughly researching and understanding a company, and if it clearly meets the 15 points he set forth, you should make a meaningful investment.

•1. Don't overstress diversification.

•Fisher would agree with Mark Twain when he said, "Put all your eggs in one basket, and watch that basket!”

•2. Don't follow the crowd.

•Following the crowds into investment fads, such as the "Nifty Fifty" in the early 1970s or tech stocks in the late 1990s, can be dangerous to your financial health.

•2. Don't follow the crowd.

•On the flip side, searching in areas the crowd has left behind can be extremely profitable.

•2. Don't follow the crowd.

•Sir Isaac Newton once lamented that he could calculate the motion of heavenly bodies, but not the madness of crowds. Fisher would heartily agree.

•3. Don't quibble over eighths and quarters.

•After extensive research, you've found a company that you think will prosper in the decades ahead, and the stock is currently selling at a reasonable price.

•Should you delay or forgo your investment to wait for a price a few pennies below the current price?

•3. Don't quibble over eighths and quarters.

•Fisher told the story of a skilled investor who wanted to purchase shares in a particular company whose stock closed that day at $35.50 per share.

•However, the investor refused to pay more than $35.

•The stock never again sold at $35 and over the next 25 years, increased in value to more than $500 per share.

•The investor missed out on a tremendous gain in a vain attempt to save 50 cents per share.

•3. Don't quibble over eighths and quarters.

•Even Warren Buffett is prone to this type of mental error.

•Buffett began purchasing Wal-Mart many years ago, but stopped buying when the price moved up a little.

•Buffett admits that this mistake cost Berkshire Hathaway shareholders about $10 billion.

•Even the Oracle of Omaha could have benefited from Fisher's advice not to quibble over eighths and quarters.

•The Bottom Line

•Philip Fisher compiled a sterling record during his seven-decade career by investing in young companies with bright growth prospects.

•By applying Fisher's methods, you, too, can uncover tomorrow's dominant companies.

•Q&A

•There is only one correct answer to each question.

•Q&A

•Fisher was the author of which classic investment book?

–Security Analysis.

–One Up on Wall Street.

–Common Stocks and Uncommon Profits.

•Q&A

•What sorts of companies did Fisher favor?

–Young growth companies.

–Companies with large dividends.

–Companies in mature industries.

•Q&A

•Fisher's time horizon for holding a well-selected stock can best be described as what?

–Very long-term.

–Short-term.

–Three to five years.

•Q&A

•Which statement would Fisher most agree with?

–"I don't want a lot of good investments; I want a few outstanding ones."

–"It is important to own a well-diversified portfolio of over 50 stocks to reduce risk."

–"Large capitalization companies in mature and steady industries are the best investments.”

•Q&A

•According to Fisher, management quality:

–Is irrelevent so long as the company is growing.

–Should cause you to avoid a stock if there are serious stewardship issues.

–Should not delegate to lower-level employees.

•

•http://www.safehaven.com/article/20772/investment-basics-course-505-wise-analysts-philip-fisher

•

The Technique of Fundamental Analysis

Fundamental analysts believe that the market is 90% logical and only 10% psychological.  Value is related to a company's assets, its expected growth rate of earnings and dividends, interest rates, and risk.  By studying these factors, the fundamentalist arrives at an estimate of a security's intrinsic value or firm foundation of value.

Fundamentalists believe that eventually the market will reflect the security's real worth.

The fundamentalist strives to be relatively immune to the optimism and pessimism of the crowd and makes a sharp distinction between a stock's current price and its true value.

In estimating the firm-foundation value of a stock, the fundamentalist's most important job is to estimate the firm's future stream of earnings and dividends.  The worth of a share is taken to be the present or discounted value of all the cash flows the investor is expected to receive.  The analyst must estimate the firm's sales level, operating costs, tax rates, depreciation, and the sources and costs of its capital requirements.

The fundamentalist uses four basic determinants to help estimate the proper value for any stock.

1.  The expected growth rate.
Rule:  A rational investor should be willing to pay a higher price for a share the larger the growth rate of dividends and earnings.
Rule:  A rational investor should be willing to pay a higher price for a share the longer an extraordinary growth rate is expected to last.

2.  The expected dividend payout.
Rule:  A rational investor should be willing to pay a higher price for a share, other things being equal, the larger the proportion of a company;s earnings that is paid out in cash dividends.

3.  The degree of risk.
Rule:  A rational (and risk averse) investor should be willing to pay a higher price for a share, other things being equal, the less risky the company's stock.

4.  The level of market interest rates.
Rule:  A rational investor should be willing to pay a higher price for a share, other things being equal, the lower the interest rates.


The above valuation rules imply that a security's firm-foundation value (and its price-earnings multiple) will be higher 

• the larger the company's growth rate and the longer its duration;
• the larger the dividend payout for the firm; 
• the less risky the company's stocks; and 
• the lower the general level of interest rates.

In principle, such rules are very useful in suggesting a rational basis for stock prices and in giving investors some standard of value.  But before using these rules, bear in mind the following caveats.

1.  Expectations about the future cannot be proven in the present.

Predicting future earnings and dividends is a most hazardous occupation.  It is extremely difficult to be objective; wild optimism and extreme pessimism constantly battle for top place. "Forecasts are difficult to make - particularly those about the future."

2.  Precise figures cannot be calculated from undetermined data.

There is always some combination of growth rate and growth period that will produce any specific price.  In this sense, it is intrinsically impossible, given human nature, to calculate the intrinsic value of a share.  

The point to remember is that the mathematical precision of fundamental value formulas is based on treacherous ground: forecasting the future.  "God Almighty does not know the proper price-earnings multiple for a common stock."

3.  What's growth for the goose is not always growth for the gander.

It is always true that the market values growth, and that higher growth rates and larger multiples go hand in hand.  But the crucial question is:  How much more should you pay for higher growth?  

There is no consistent answer.  In some periods, the market was willing to pay an enormous price for stocks exhibiting high growth rates.  At other times, high growth stocks commanded only a modest premium over the multiples of common stocks in general.   Growth can be as fashionable as tulip bulbs, as investors in growth stocks painfully learned. 

From a practical standpoint, the rapid changes in market valuations that have occurred suggest that it would be very dangerous to use any one year's valuation relationships as an indication of market norms.  However, by comparing how growth stocks are currently valued with historical precedent, the investor should at least be able to isolate those periods when a touch of the tulip bug has smitten investors.

Why might fundamental analysis fail to work?

There are three potential flaws in this type of analysis.
1.  The information and analysis may be incorrect.
2.  The security analyst's estimate of "value" maybe faulty.
3.  The market may not correct its "mistakes", and the stock price may not converge to its value estimate.