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For Maximum Total Return Go for Growth
Posted by: Chuck Carnevale (IP Logged)
Date: October 25, 2013 04:59PM
Not all investors are the same. Therefore, not all investors share the same goals and objectives.
Consequently, there are numerous strategies and investing methods available to choose from. Moreover, it also goes without saying that the investment strategy that’s right for me may not be right for you. For that reason, it’s imperative that each individual looks for the strategy that is right for their own individual goals, objectives, risk tolerances and status. By status, I’m referring to how many years you have left before retirement.
Additionally, the time the individual investor has left in front of them prior to retirement may be one of the most important considerations regarding what type of approach or strategy they should embrace. Although many advisers like to offer tidy rules-of-thumb about how this decision should be made, I believe that common sense and personal preference should be the driving forces. With investing, one size rarely fits all.
For example, common sense would dictate it is logical that younger investors with more time available could justify taking on more risk. Therefore, high-growth stocks might be appropriate investments during their accumulation phase because achieving the highest total return possible might make the most sense. However, achieving higher returns usually comes with taking on higher risk. Consequently, a very conservative investor even with lots of time in front of them may not possess the risk tolerance to go for total return exclusive of dividends.
In my most recent article titled Trying to Beat the Market Is a Fool’s Errand I introduced the notion that portfolios should be built to meet the specific needs of the individual investor building it. In that article I utilized an example of a dividend growth portfolio that generated a 3% yield that would meet a hypothetical retiree’s specific income needs. In other words, I focused on income over total return. With this article I will change that focus to investing for the highest total return possible during the accumulation phase.
I typically write about dividend growth investing because personally I believe it is the most appropriate strategy for investors of my age and status. However, I didn’t always see it that way, especially when I was younger. My early investing career started out with a hunger for maximum total return or growth. In those days, I was willing to take on more risk, but I never allowed myself to be reckless. Throughout my career, I’ve always believed that you can pay too much for even the best of companies, and that view included investing in fast-growing businesses. Because then and now, I believe you make your money on the buy side. Moreover, that principle applies to conservative and aggressive investments alike.
Nevertheless, even though my temperament for taking risk has diminished, I must admit that even today I appreciate the power and performance of a high-growth stock. Years of study and analysis have shown me that investing for high-growth offers rewards that can be orders of magnitude beyond what a blue-chip dividend paying stalwart could ever provide. Yes, there is more risk, but if approached properly the total returns from investing in high-growth stocks can be incredible. Therefore, I believe I owe it to regular readers to at least introduce them to just how profitable investing for growth can be.
My Personal Definition of a Growth Stock
Although there may be many definitions of what a growth stock is, my own definition is rather simple and straightforward. For me to consider a company a growth stock, or even a great growth stock, I focus on above-average earnings growth. When investing for growth, my minimum threshold for earnings growth is 15% per annum or better. On the other hand, when looking for growth I will often search for a minimum of 20% per annum earnings growth, because the faster - the better - to my way of thinking.
My position is based on the principle that earnings represent the ultimate driver of future return. Moreover, this applies equally to dividend paying stocks as it does to growth stocks. After all, the primary source of dividends is clearly earnings. On the other hand, assuming the investor invests at a reasonable valuation, earnings growth is also the primary source of capital appreciation in the long run.
At this point, many readers may be thinking that earnings growth of 20% or better might be unrealistic or even unattainable. Admittedly, companies that grow earnings at 20% or better are rare, but frankly, not as rare as many might think. Growth of this nature is usually found with younger and even smaller companies, but not always. However, as a general rule, younger smaller companies are where the fastest growth is usually found. Furthermore, investors must understand and realize that achieving high-growth rates over a sustained period of time is quite difficult.
The Incredible Benefits of Earnings Growth
I will discuss the risks associated with investing in high-growth stocks in more detail later in the article. However, at this point I would like to share some observations about investing in high growth stocks that I feel are both interesting and important. As regular readers of mine know, I am a stickler for fair valuation. Personally, I like to refrain from ever investing in any type of company at prices or valuations that I believe exceed what a company is truly worth.
On the other hand, one of the great benefits of investing in high-growth stocks is that as long as they are in a high-growth phase, you can pay more than they are worth and still make money. Of course, if you find them at or below True Worth™ value then you can make more money while simultaneously taking on less risk. Lower risk and higher return is certainly a desirable objective. However, my point here is that as long as they are growing fast, there is no price or valuation, within reason, that you could pay and not make some money.
Melodramatic Examples of the Power and Performance of Investing in Growth Stocks
In order to illustrate my last point regarding how you can even overpay for a great growth stock and still make money I offer the following eight examples of powerful growth stocks that have achieved my historical 20% per annum threshold. However, I would simultaneously like to also provide an admittedly rather melodramatic illustration of just how powerfully-rewarding investing in growth stocks can be.
To be clear, I ask the reader to participate with me in an exaggerated hypothetical scenario in order to fully experience the power and performance of investing in growth stocks. With each of the following examples I am assuming that an individual investor had $1 million available to invest into a single stock (business) approximately 15 years ago. My purpose in making this rather preposterous assumption is to create a scenario that is analogous with how the majority of the richest people in the world had accumulated their great wealth.
Billionaires such as Bill Gates, Larry Ellison, Mark Zuckerberg, Larry Page, Sergei Brin and numerous others all accumulated there great wealth by founding and owning a single business. Therefore, just for the fun and shock value of it, my scenario pretends that an individual, through either luck or smarts, invested the majority of their available wealth ($1 million) into one of the eight single businesses that follow. Of course, I don’t recommend this, but the results are rather staggering and illustrative of the power and performance available from investing in growth stocks.
Starbucks Corp. (SBUX)
The following 15 calendar year Earnings and Price Correlated F.A.S.T. Graphs™ on Starbucks Corp illustrates how you can overpay for a great growth stock and could still make money. The reader should note that Starbucks’ stock price has a legacy of premium valuation (price consistently above the orange earnings justified valuation line). However, due to its fast historical earnings growth rate of 21.8% per annum, even if you purchased Starbucks’ stock at its peak price and valuation in 2006 at $40 per share, today’s price of $79.05 per share represents a doubling of your money.
However, even though that is true, the cost of overpaying for Starbucks would have meant several years of underperformance with some of it severe. By late 2008 the stock price would have fallen to just over $7 a share representing more than an 80% drop from the high. Obviously, few investors could tolerate that level of risk and volatility. On the other hand, those investors that were investing in the business over just buying the stock, and that did have the patience to wait, would have recovered reasonably well. Importantly, I am not advocating that it’s okay to overpay for a great business. Instead, I’m simply illustrating that even if you do, you can still make money as long as the business continues to grow long term. This example is simply offered to illustrate the power of a company with a very high rate of earnings growth. In other words, a high rate of earnings growth can even overcome a bad investment decision mistake.
The reader might also find it interesting to note by looking at the horizontal change per year (Chg/Yr) column at the bottom of the graph that Starbucks’ earnings growth rate accelerated from 21% per annum on average to almost 26% per annum as it came off of the low recessionary earnings base. Also, note that Starbucks initiated a dividend in fiscal year 2010 (the light blue shaded area on top of the orange line).
The initiation of the dividend brings me to another interesting aspect of investing for growth when you have plenty of time in front of you before retirement. This is one of many examples of fast-growing companies that eventually begin paying a dividend as their businesses mature. Therefore, this can lead to a natural transition from pure growth to an income-producing investment. In other words, it is possible that growth stocks could provide income when needed as an investor enters retirement years without having to harvest shares.
The following 15-year performance results associated with the above graph clearly illustrate the performance power of investing in a fast-growing stock during the accumulation phase. Also take notice of the dividend income stream that kicked in starting in calendar year 2000. Remember, the original investment was $1 million.
7 Additional- Wouda- Coulda- Shoulda- Extraordinary High-Growth Stocks
What follows are seven additional examples of companies that have provided long-term shareholders extraordinary total returns. They are presented in order of lowest to highest total return. My objective in presenting all of these historical examples is not to imply that I invested in all or any of them 15 years ago, although I wish I had. All this exercise is designed to illustrate is simply how powerful the results can be through investing in companies that are growing earnings at very high rates. In other words, these are examples to provide the reader awareness of what a growth stock potentially can offer.
Coach Inc. (COH)
Coach represents another example of a high growth stock that is morphing into a dividend payer. However, earnings growth since it went public in 2000 has been exceptional at more than 30% per annum and generated extrodinary shareholder returns in spite of today’s low valuation.
Even though Coach has only been paying dividends in recent years, it would currently be producing over $400,000 in annual dividends. Moreover, the original $1,000,000 investment is worth over $17,000,000 today.
Tractor Supply Company (TSCO)
You might not think a store selling agriculture products would be a great growth stock, but Tractor Supply Co certainly has. However, it’s only fair to point out the uncharacteristically high valuation its stock commands today.
A $1,000,000 investment 15 years ago would be worth over $50,000,000 today. As another growth stock that morphed into a dividend payer, I think a retiree could live off of their more than substantial current dividend.
Apple Inc (AAPL)
Depending on how its stock price is acting, Apple Inc goes from being perhaps the most revered to the most reviled company. However, it is undeniable that this company represents one of the fastest-growing and most powerful growth stocks of modern times. Remember, this is a look at what a hypothetical $1 million investment in Apple 15 years ago would have achieved. What might happen going forward is yet to be determined, but not the subject of this scenario.
The shock value that I’m going after with this example is quite extraordinary. Since the beginning of calendar year 1999 Apple Inc has grown earnings at the extraordinary compound annual rate of 32.2% per annum. Earnings growth of that magnitude is capable of providing extraordinary performance to long-term shareholders of the business.
It’s important with this example, and the other high-growth stock examples that I will later present, that the focus is on being a shareholder of the business over being a trader of the stock. After all, my hypothetical exercise is derived from the model of people becoming extremely rich by creating and/or owning a single stock.
Imagine investing your $1 million nest egg into Apple 15 years ago. Today your investment based on capital appreciation alone would be worth over $50 million. Moreover, as we saw a similar transition to a dividend paying stock with Starbucks earlier, in calendar year 2013 your dividend income would be over $1 million, and possibly growing. Albeit the risks were high, and few investors would have invested their entire nest egg into Apple’s stock. However, I daresay there are several Apple shareholders working within the company that have enjoyed similar results.
Cognizant Technology Solutions (CTSH)
Cognizant Technology Solutions has grown earnings at approximately 39% per annum. Perhaps the most impressive characteristic of this company is not just fast growth, but also how consistently it has increased earnings year after year.
Even though Cognizant Technology Solutions has never paid a dividend, a $1,000,000 investment 15 years ago would now be worth over $68,000,000. Just a little bit of harvesting could provide enough cash to live off of for life.
Middleby Corp. (MIDD)
You might not think that selling restaurant supplies would be so profitable. However, Middleby Corp has grown earnings at over 32% per year for the past 15 years with only a minor hiccup in 2009.
As incredible as it may seem, a $1,000,000 investment in Middleby 15 years ago is worth over $126,000,000 today. Although the company currently does not pay a dividend, the few dividends they did pay in years past were substantial.
Monster Beverage Corp (MNST)
Monster Beverage Corp grew earnings at almost 35% per annum since calendar year 1998. As you will soon see, the results of investing $1 million in this company are even more shocking than what we saw with Apple. However, this is pure unadulterated total return as Monster Beverage does not pay a dividend.
If you had invested $1 million in Monster Beverage Corp on December 31, 1998, today that investment would be worth over $170 million. Again, this company has not, and does not, pay a dividend. However, I believe I could figure out a way to get an adequate amount of income out of a $170 million nest egg.
Green Mountain Coffee Roasters (GMCR)
People love their coffee, and Green Mountain Coffee Roasters has exploited this desire on a monumental degree. Earnings growth has averaged over 57% per annum since 1999. Recent price action has been volatile which could alarm the less than courageous investor.
However, for those with the fortitude to have stayed the course, their long-term return would have been staggering. A $1,000,000 investment 15 years ago is worth over $300,000,000 today. With returns like that, a person might forgive a lack of dividends.
The 15-Year Track Record of Dividend Playing Blue-Chips for Contrast
In order to contrast how powerful the above results are I provide the following on a couple of my favorite blue-chip dividend paying stalwarts. High-growth stocks might not be appropriate choices for conservative investors. However, I believe it would be a huge mistake to not at least consider the potential that high-growth can offer. Frankly, I sleep better at night owning blue-chip dividend paying stocks. On the other hand, an awareness of what other classes of stocks can offer should be a component of every stock investor’s knowledge base, at least in my opinion.
Johnson & Johnson (JNJ)
Colgate-Palmolive Co (CL)
As an aside, both of the above blue-chip dividend paying stalwarts rather dramatically outperformed the S&P 500. But more importantly, although capital appreciation was stronger with both, I contend it is the attractive income component that is most beneficial to investors in retirement.
It’s Risky To Be Too Early
During a recent conversation about investing strategies with a young colleague of mine, who incidentally favors dividend stocks over growth stocks, he expressed his primary reason why. My young colleague is concerned that you cannot identify a great growth stock early enough to reap the rewards they offer. Frankly, I believe he is partially, but not totally, correct with his concern. On the other hand, I argued that you don’t have to be too early to reap significant rewards from investing in growth stocks, just early enough.
Next I went on to share my own personal criteria that I utilized over my career to identify exciting fast-growing companies that I could feel comfortable investing in. My criteria are rather simple and straightforward. Since I do not want to invest too early, I look for companies that have achieved a minimum of 5 years (preferably 10 years) of historical 20% earnings-per-share growth or better. Moreover, I favor consistent earnings growth over cyclical.
Furthermore, although I am willing to occasionally examine smaller companies, I gravitate towards companies with a market cap of at least one half billion dollars. Stated more simply, I want companies that have already achieved a reasonable level of success in whatever business they operate in. But most importantly, I want to stress that these are pre-extensive research criteria. In other words, I use these criteria to identify companies that I would be willing to make the effort to research more comprehensively prior to investing in them.
As an interesting aside, and to illustrate that you don’t have to be too early, there have been many great growth stocks that maintained earnings growth rates of 20% or better for several decades. Well-known large-cap names such as McDonald’s and Microsoft achieved earnings growth of 30% or better for several decades in a row. Of course, they achieved this phenomenal growth when they were younger and smaller enterprises. But the point I’m making here is that high-growth rates can persist long enough to provide shareholders, willing to take some risk, with extraordinary long-term total returns.
Stamps.com Inc (STMP) - Why I Avoid IPOs
To continue with my “it’s risky to invest too early” theme I offer the following post-IPO record of Stamps.com Inc. I placed the red circle around the first approximately two years of this company’s publicly-traded existence. Clearly, investing in this company at their IPO would have provided very exciting returns over the next six months or so. However, since there were no real earnings to support the stock, price performance during calendar year 2000 presented what might be called an exhilarating collapse. Of course that’s assuming you consider a massive loss of money exhilarating.
From calendar year 2001 to 2005, the stock presented a decent recovery, but nowhere close to its 1999 and 2000 peaks. The company did pay a substantial special dividend of $3.50 per share in 2004 and again a $2 special dividend in 2010. Finally, the company did begin to show some profit in 2005. However, although stamps.com Inc remained profitable for the timeframe 2006-2009, earnings did shrink from the company’s highest level of profitability in 2006. But then from 2009 to current, business results began to reflect the initial hype originally expected on its IPO debut.
Clearly, investing in Stamps.com too early produced average, but rather disappointing results considering the initial hype. Long-term owners of this business didn’t lose money, but I would believe that initially they all expected much stronger results.
On the other hand, investors who waited for profitability to manifest fared much better. From calendar year 2009 to current time, operating earnings grew by over 39% per annum. This was more like it.
Consequently, owning the stock during its profitable earnings growth phase was much more rewarding. Even though the S&P 500 has produced remarkably strong results coming out of the Great Recession, the very fast earnings growth of Stamps.com Inc allowed it to do significantly better. Growth stocks can be very rewarding, but it doesn’t always pay to invest too early.
Going For Growth Candidates for Further Research
With my first 8 high growth stock examples, I reviewed their 15-year historical track records. After such high rates of earnings growth over such an extended period of time, I caution the readers to realize those extraordinary growth rates may be behind them. Most of these companies are still expected to continue growing at above-average rates, but nowhere near what they did in the past. However, not all of them can be bought at attractive valuations today, although a few of them can.
Therefore, the key to even the possibility of duplicating similar types of future performance would require finding companies that have the ability to grow earnings very fast in the future. I screened the universe available through the F.A.S.T. Graphs™ screening tool looking for companies that were forecast to grow earnings at a minimum of 15%. However, my primary objective was to identify companies that might be able to grow even faster than that.
Moreover, I looked for companies that have produced a high rate of earnings growth for at least the past 5 years. Then I screened my list down to 15 candidates that appear worthy of the necessary comprehensive research effort required before I would ever invest. To be clear, I have not completed that research effort at this time, and only offer the following list as potential high future growth candidates. First I have listed them in order of highest potential future return (based on earnings growth) to lowest as follows.
By Cap-Size and Growth
Next, I created a portfolio review based on cap-size and earnings growth rate. As expected, most of these candidates, but not all of them, are small and mid-cap companies.
Then, since I do believe in diversification, I created a portfolio review by sector. I was pleased to discover that these 15 potential high growth candidates were spread over 6 different sectors.
For those interested in seeing each of these high growth candidates in greater detail, follow this link:
[b]Addendum To Going For Growth Portfolio
[/b]The Power of Compounding
“Compound interest is the eighth wonder of the world. He who understands it, earns it ... he who doesn't ... pays it.” Albert Einstein
The incredible performance results that I shared with my historical examples above were produced by the power of compounding. As investors, we must recognize and realize that when we buy a common stock we are really buying its earnings power. The compounding power of a faster growth rate over a slower growth rate produces geometric rather than arithmetic results.
The following compounding table showing growth rates from 5% to 30% over 10 years illustrates how powerful compounding is. The yellow highlights on the table contrast 10% growth versus 20% growth. This illustrates how double the growth rate produces more than double the returns even in as short a time period as 10 years. A little time studying the table should enable you to understand compounding as Albert Einstein suggests above.
Investing in High-Growth Stocks - The Power and Protection of Diversification
The following table illustrates what I call the power and protection of diversification. Achieving a 20% annual compound rate of return is an extremely difficult task and achievement. However, throughout this article I have presented a sampling of companies that have achieved that level of growth historically. Moreover, I provided 15 companies where the majority is expected to grow earnings by 20% in the future. I think it would be naïve to expect all 15 of them to achieve the goal.
The following table shows that even if 80% of the companies were so wrong that they went to zero (very unlikely) and only 20% achieved the goal, the total portfolio would still be profitable. Furthermore, if only 50% achieved the goal, thanks to the power of compounding, the annualized return would still exceed 12%. Of course, this is all hypothetical and I only offer it for perspective. There is great power in compounding.
Summary and Conclusions
Investing in high growth stocks is certainly not for everyone. The risks are high, but the rewards can be extraordinary when you are right. The two keys are forecasting earnings within a reasonable degree of accuracy, and having the fortitude to stay the course as long as business remains strong. Price volatility should be expected.
Admittedly, few investors possess that kind of staying power. Consequently, achieving the incredible returns highlighted in this article might be unrealistic to expect. However, the math is real. My purpose in presenting this information was simply to illustrate what could be possible from investing in strong businesses with fast growth. Perhaps even the most conservative dividend growth investor could use a little turbo charging in their portfolios. As I previously said, I admire the power and performance of a great growth stock.
Disclosure: Long AAPL, CTSH, MIDD, GMCR, JNJ & CL at the time of writing.
Disclaimer: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the earnings growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. We do not recommend that anyone act upon any investment information without first consulting an investment advisor as to the suitability of such investments for his specific situation.
Stocks Discussed: SBUX, TSCO, AAPL, CTSH, MIDD, MNST, GMCR, JNJ, CL, STMP,
Re For Maximum Total Return Go for Growth
Posted by: mikemarce (IP Logged)
Date: October 26, 2013 08:28AM
Chuck: Thanks for your always insightful articles. I always look forward to your thoughts and approachs to investing.
Stocks Discussed: SBUX, TSCO, AAPL, CTSH, MIDD, MNST, GMCR, JNJ, CL, STMP,