What is a growth investor? Well, good-looking, yes. Intelligent, for sure. Oh, you wanted something more?
All right then. Let me admit that it’s difficult to define exactly what makes a growth investor. Even growth investors disagree among themselves.
Ultimately, I invest in stocks to make money. (Yes, I know what you’re thinking: “Thank you Captain Obvious.”) Because I want to profit on my investments, I’m a value investor to some degree. So are we all. We buy stocks today that we expect to sell for a profit in the future.
The key difference between me and the classic value investor is that I take a long term perspective. I look for stocks that can grow their earnings faster than average for years to come. This means I don’t get turned off just because a stock happens to sport ratios that make it look expensive by traditional measures such as price-to-earnings or price-to-sales.
How do I decide if a stock is worthy of the “growth” label? It depends on where I think a company is in its life cycle. I don’t think you can identify a growth stock by looking at a single number.
Earnings growth, for instance, is important. However, there are too many situations when focusing on earnings is the wrong thing to do.
Netflix, which delivers TV shows and movies over the Internet and via DVDs, provides a good example. At the moment, its stated goal is to grow its global base of subscribers, each of whom pays $8 per month.
After achieving success in the United States, the company has just embarked on a global growth strategy. Netflix’s plan is to open service in a new country, get that country to profitability, then re-invest in a new country.
On the conference call following the company’s latest financial results, one analyst asked, “So doesn’t this mean that the Street should not assume meaningful growth in reported net income for the next few years?” Reed Hastings, CEO of Netflix, replied, “Yes, that’s completely consistent with what we’ve been saying.”
Makes sense. If I were in Mr. Hasting’s shoes, I would care about subscriber growth and per-country profitability, because that is what is going to drive profits over the long haul. I would put very little emphasis, if any, on short-term earnings growth.
But that’s not true in all cases.
Google, for instance, is a fairly mature company in the world of online advertising. It generates the vast majority of revenue and profitability from Google Adwords and Google Adsense. I expect to see revenue growth continue as Google pushes further into in-video advertising (YouTube) and extends its advertising products to mobile devices (Android).
So in the case of Google I care about earnings growth happening now, not in a few years. I’m not going to be satisfied by revenue growth alone. Google isn’t an attractive stock to me without earnings growth.
As an investor, I like to think of myself as a company owner. I ask myself what I would be focused on if I were CEO. Then I look for evidence of growth along those lines.
When a company is investing in building its business, earnings growth is not the right metric. Revenue growth is better. I might even have to look beyond revenue and evaluate the user base. This would have been the case for social networking companies like Facebook or Twitter before they began to derive significant advertising sales.
As a company matures, my focus moves towards earnings growth. But earnings growth doesn’t necessarily mean big cash flow growth. Growing companies often reinvest their cash flow from operations in capital expenditures to support more growth.
That’s fine by me. It’s exactly what I would do. It’s all about planning for the long term rather than pleasing the investment community and their obsession with short term results. Does that make me a growth investor? So be it.
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