Interesting Morningstar Series
Morningstar has recenty run a few stories about a research project they're doing on growth stocks -- definitely worth a read.
The first article, How Much Should You Pay for a Growth Stock, explains what they're doing (for the full research data and articles you have to subscribe to their premium services). Basically, they went back to 1995 and looked at the growth stocks from that year that are still in existence today (and for the most part, still considered growth stocks today). They applied their "margin of safety" assumptions and determined what price you could have paid for those stocks and still had a ten year (roughly) return to date that beat the market's roughly 11% return for that time period. They're doing this for shorter time periods, too, beginning in 2000 and 2005, and I hope they publicize that information as well -- it'll be interesting to see what this means for shorter holding periods.
The results are pretty remarkable -- the chart lists a lot of companies that we've all heard of and gives their PE at the time and the PE you could have paid for them and still beat the market for your 10+ year holdling period.
A few really piqued my interest that are in my portfolio or have been in the past -- Chicos (CHS), for example, was trading at a PE of about 12 ... but you could have massively overpaid for it and got it at a PE of 491 and you would have STILL beat the market. Goes to show you how much one great stock can mean to a long term portfolio.
Of course, no need to tell that to Dell fans -- they may have felt nervous about that PE of 18 for a small computer company with lots of competition, but it turns out they would have beaten the market even if they paid up to a PE of 350.
In plainer terms, the split adjusted price of CHS was 28 cents, but even if you had paid over $11 you would have still beat the market. For Dell, it was 64 cents and you could have paid over $12 and still had better than an 11% annual return. Pretty remarkable.
Companies like Motorola, or Coca Cola, however, didn't fare so well -- anyone who has held those for ten years, or many others on the list, has failed to beat the market and maybe even lost money.
Part two of the same article gives some preliminary conclusions, and while they have the kind of stodginess that sometimes turns folks off from Morningstar, they also make a lot of sense.
What do they recommend? Well, read the article ... but, basically, we should still look for a margin of safety in the purchase price, growing future demand for the product or service and a growing competitive advantage (moat), and growth-oriented management.
I think I've gotten better and looking for some parts of that -- the growing future demand and growing moat are key considerations and they coincide with the "story" or "theme" of a stock, business or industry, the part that I find interesting to research.
The part that I have trouble with is the buying price -- since I'm usually interested in finding companies that have real potential to show dramatic growth, I have an awful time computing a margin of safety in the price I pay for a company. I often fall back on the PEG ratio, which Peter Lynch really liked (Price/Earnings/Growth -- basically, is the PE ratio higher or lower than the future growth rate), but I find myself trying to estimate future growth for a company because I don't often put a lot of stock in analyst growth predictions, especially for the very small companies that I'm most likely to get interested in and that seem to be very capable of blowing through analyst numbers (or cratering when the miss them on the flip side, of course).
I guess that's where I need to do me some more book learnin' -- I've been paying attention to the Motley Fool's great investor education materials, and they seem to follow a lot of the same strictures as Morningstar in dealing with free cash flow and discounting, and their investor education center has some good articles on cash flow-based valuation and similar topics. The discounting aspect of it is pretty simple math as long as you've got a calculator handy, so we're all capable of that.
And that, finally, is the problem with having a diversified portfolio with a large number of stocks, as I do -- I'm not going to rerun a disounted cash flow analysis for every company every quarter, or even every year, so I focus probably a little more than I should on themes, stories, and PEG ratios even though cash flow is often a much better measure for long-term growth than earnings.
Hopefully I'll get better at this ... we'll see.
The first article, How Much Should You Pay for a Growth Stock, explains what they're doing (for the full research data and articles you have to subscribe to their premium services). Basically, they went back to 1995 and looked at the growth stocks from that year that are still in existence today (and for the most part, still considered growth stocks today). They applied their "margin of safety" assumptions and determined what price you could have paid for those stocks and still had a ten year (roughly) return to date that beat the market's roughly 11% return for that time period. They're doing this for shorter time periods, too, beginning in 2000 and 2005, and I hope they publicize that information as well -- it'll be interesting to see what this means for shorter holding periods.
The results are pretty remarkable -- the chart lists a lot of companies that we've all heard of and gives their PE at the time and the PE you could have paid for them and still beat the market for your 10+ year holdling period.
A few really piqued my interest that are in my portfolio or have been in the past -- Chicos (CHS), for example, was trading at a PE of about 12 ... but you could have massively overpaid for it and got it at a PE of 491 and you would have STILL beat the market. Goes to show you how much one great stock can mean to a long term portfolio.
Of course, no need to tell that to Dell fans -- they may have felt nervous about that PE of 18 for a small computer company with lots of competition, but it turns out they would have beaten the market even if they paid up to a PE of 350.
In plainer terms, the split adjusted price of CHS was 28 cents, but even if you had paid over $11 you would have still beat the market. For Dell, it was 64 cents and you could have paid over $12 and still had better than an 11% annual return. Pretty remarkable.
Companies like Motorola, or Coca Cola, however, didn't fare so well -- anyone who has held those for ten years, or many others on the list, has failed to beat the market and maybe even lost money.
Part two of the same article gives some preliminary conclusions, and while they have the kind of stodginess that sometimes turns folks off from Morningstar, they also make a lot of sense.
What do they recommend? Well, read the article ... but, basically, we should still look for a margin of safety in the purchase price, growing future demand for the product or service and a growing competitive advantage (moat), and growth-oriented management.
I think I've gotten better and looking for some parts of that -- the growing future demand and growing moat are key considerations and they coincide with the "story" or "theme" of a stock, business or industry, the part that I find interesting to research.
The part that I have trouble with is the buying price -- since I'm usually interested in finding companies that have real potential to show dramatic growth, I have an awful time computing a margin of safety in the price I pay for a company. I often fall back on the PEG ratio, which Peter Lynch really liked (Price/Earnings/Growth -- basically, is the PE ratio higher or lower than the future growth rate), but I find myself trying to estimate future growth for a company because I don't often put a lot of stock in analyst growth predictions, especially for the very small companies that I'm most likely to get interested in and that seem to be very capable of blowing through analyst numbers (or cratering when the miss them on the flip side, of course).
I guess that's where I need to do me some more book learnin' -- I've been paying attention to the Motley Fool's great investor education materials, and they seem to follow a lot of the same strictures as Morningstar in dealing with free cash flow and discounting, and their investor education center has some good articles on cash flow-based valuation and similar topics. The discounting aspect of it is pretty simple math as long as you've got a calculator handy, so we're all capable of that.
And that, finally, is the problem with having a diversified portfolio with a large number of stocks, as I do -- I'm not going to rerun a disounted cash flow analysis for every company every quarter, or even every year, so I focus probably a little more than I should on themes, stories, and PEG ratios even though cash flow is often a much better measure for long-term growth than earnings.
Hopefully I'll get better at this ... we'll see.
This article posted by One Guy @ 11/19/2005 02:13:00 PM 0 comments
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