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Value Investing in Growth Companies

first posted: 2024-01-27 08:43:16.159762

a 2013 published book by Rusmin Ang, Victor Chng

The authors suggest value-growth stock picking, or gaarp.

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image credit: Wiley

Definition

Grew at 15% for the last 5 years:

  • revenue
  • income
  • cashflow

Target for authors is small companies (less than 1bn mkt cap in Asia)

Myth

  • higher growth rate is better: avoid debt financed companies and cyclical sector companies (construction, shipping, property), stay in the 15% to 50% growth range
  • fast growing sector is best: some fast grower outside the tech sector do well (authors cite Boustead)
  • there is no growth company at bargain price: author recommend methods to avoid companies confronted with problems leading to permanent loss of profitability
  • fast growers have small market cap: authors cite Noble Group (defaulted) as a larger fast growing company. They mention that as a company becomes larger, its stock is more liquid but this is not a concern for small investors.
  • small companies are not covered by analysts: according to authors, companies in Asia have analysts even when they are small
  • growth companies pay little dividend: authors suggest a dividend payout ratio of 20% to 50% even for fast growing companies which need funds to finance their growth.

Return Target

In his 1984 article: Investors of Graham and Doddsville, Warren Buffet cites a set of value investors with returns in the 18% to 32% range. Value investors benefit from long term appreciation, dividends and potential acquisition by a larger company.

Business

  • understand business model thouroughly
  • look out for simple/easy to understand businesses
  • look out for moat
  • visit company and ensure it has a growth plan
  • check if country in which company plans to operate has favorable demographics
  • understand risks to better react in crisis

Management

  • acts as owner, report candidly on mistakes, takes responsibility
  • is compensated on profit
  • does not issue shares or options unless opportune
  • is trustworthy and aligned to shareholders
  • holds substantial amount of shares in the company
  • passionate about the business
  • seeks to increase revenue and profit
  • buys back shares when undervalued
  • is able to finance growth internally

Financial Statements

The book gives basic definitions of accounting terms. In the last section, without statistics, the authors want to see over 3 to 5 years. I write in parenthesis the putative reasons I assign to their criteria :

  • revenue > 15% (growth?)
  • net profit > 15% (growth?)
  • cashflow > 15% (growth?)
  • net profit margin > 8% (to have margin of safety?)
  • return on equity > 15%
  • debt to equity < 0.5
  • Cash Ratio > 0.5
  • Dividend Payout Ratio in 15%-50%
  • Capex ratio < 80%
  • Positive Free Cash Flow

This numbers are for the authors a rule of thumb, consistency is key in last 3-5 years.

Valuation

Mentions PE, PEG, and Earning Growth model, quotes John Burr Williams' Theory of Investment Value.

  • undervalued: PE<5, PEG<0.5, margin of safety > 50%
  • fair value: 5<PE<10, 0.5<PEG<1, 50%>margin of safety>0
  • overvalued: PE>15, PEG>1, margin of safety<-10%
  • grossly overvalued: PE>20, PEG>2, margin of safety<-20%

Screening

  • Suggest screening several companies within same industry
  • trend of revenue, net profit and cashflow
  • compare growth rates CAGR>15%
  • consistent margin
  • debt to equity ration <0.5 and cash > debt
  • consistent roe>15% capex<80%, positive FCF and div payout < 50%
  • buying only if business, management, numbers, valuation pass
  • monitor at least quarterly all your holdings
  • sell if anything fails

Portfolio Management

  • <10 stocks in developped, 10 to 20 stocks for developping countries. SGX is considered developped
  • some companies are diversified internally
  • sector diversification is also important
  • place higher bets on companies/sector you understand best

Do's and Don't

  • be a long-term investor, do not attempt to time the market
  • do not invest in IPO or hyped companies
  • check consistency of company earnings and revenues
  • check the credibility and integrity of management, numbers only will give value traps
  • sell losers and keep winners
  • keep portfolio limited to 10 stocks if invested in developped countries

Conclusions

All the above comes from the content of the book, I am a bit surprised that they recommend only 10 stocks. 20 or 30 stocks portfolio, generally exhibit lower volatility according to research, and any number higher than that eliminates lumpiness that could cause idiosyncratic risk.