Sunday, 1 December 2013
It is difficult to buy growth.
Investors would be most delighted if they could lay their hands on a company undergoing rapid growth that sees its revenue and profits rising steadily and aggressively over time. This sort of investment tends to bring about the greatest wealth increase for investors as the share price grows many folds over years.
Philip Fisher laid down his arguments for growth investing and explained the thought process and framework in his classic investment book ‘Common Stocks and Uncommon Profits’, widely regarded as the bible for growth investing. He advocated the 15 points of key assessment criteria for a company to fulfill, in order to be considered a good growth stock.
If one has read through the book especially on the 15 points and the ‘Scuttle butt’ research method, one will realise that the 15 points criteria are largely qualitative and requires the investor to have sharp business acumen, the foresight to determine, or at least has an inkling of future industry development, considerable intellectual capability to envision future growth engines and preferably be within the close circle of company top management, in order to fully understand the merits of the growth stock.
This brings me to the first point why it is difficult to invest in growth.
The attributes mentioned above do not come natural. One will not have such innate analytical prowess and foresight without spending a long time to hone his business skills and acquire the ability to identify future growth directions. Furthermore, when we deal with predicting, or anticipating future growth of company, individual analytical and intellectual prowess are all the more important. Ordinary investors do not usually possess such skills.
Secondly, companies tend to be richly valued when it is expected to expand aggressively in the future. The future growth is priced in and reflected in its high PE. All is good if the company can maintain its growth rate such that it matches investors’ expectation and justify its high PE.
However, future is unpredictable and not even the insiders are able to confidently claim that the company WILL grow at 20% per annum, leave alone ordinary retail investors like us. When the company has a bad quarter with lower sales or profits, the stock price may crash as the investors realise the growth may not be so certain after all and take flight. The higher it goes, the harder it may drop. Talk about a fully-stretched rubber band when it is released.
One growth stock recently experienced such drop in its stock price due to a less-than-stellar quarterly results. Its revenue grew marginally by 2% year-on-year, but its profit fell 17% year-on-year.
How did the market react to this piece of news? The share price dropped 30% in 3 days. Its not a typo error, 30% in 3 days.
And what company is this? Super Group. The 3 in 1 instant coffee maker.
To begin with, Super Group was not trading at ridiculously high valuation. It had a PE of 24.5, while its trailing 12 months PE was 23.7, on 8 Nov 2013 before the results release. Not extremely rich valuation although not exactly cheap either.
Yet, its price fell like a skydiver without its parachute from 4.36 to 3.11 within a span of 3 days, although it has since slightly recovered back to the current price of 3.48.
So, the point I am trying to bring across is while growth investing brings about immense profit, one must be mindful of the risks it entails. No matter how much analysis or research you have done, be cognizant with the fact that a temporary hiccup in the company’s expansion plan is sufficient to bring about a sharp fall in price, and be prepared for such happening psychologically and financially. One must have the stomach to accommodate such volatility and not chicken out and sell at the worst possible time.
And if you are damn confident about your opinions on the company’s growth prospect and its ability to thrive in the long term, this may be an opportunity to buy more shares on the cheap.
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