It seems like I’ve been writing only about dividend growth stocks for what seems like forever. Therefore, I felt it would be a refreshing change to alter my focus from dividend income to pure unadulterated growth. Although I’m a major proponent of investing in dividend growth stocks, unlike many of my fellow dividend growth investor friends, I am also a big believer in the benefits of investing in non-dividend paying growth stocks with the potential for generating a higher total return.
The equity universe is broad and multifaceted. Since there are so many different types of stocks that investors can choose to invest in, I often get frustrated when I read or listen to opinions making broad statements regarding either the perils or merits of investing in common stocks in the general sense. I especially get agitated when these over-generalized discussions attempt to stereotype all stocks as being risky. The truth is that the risks of investing in common stocks are also as broad and multifaceted as are the various categories of common stocks themselves.
Furthermore, I also find it troubling when I hear over-generalized statements purporting to forecast what the future returns of common stocks are going to be. For example, the widely touted “new normal” forecast of Bill Gross describing what he calls an era of lower returns based predominantly on his views of the US and his belief in its diminishing clout in the world economies. But alas, Bill Gross is not alone; there are untold numbers of articles penned every day painting a negative picture of the US economy, and the future of common stocks. Warren Buffett shared his thoughts on the subject found here.
What I believe these prognosticators fail to consider, is the unique nature and ability of an individual company to generate returns that can widely differentiate from the equity asset class at large. Since I am a believer in building stock portfolios one company at a time, I tend to sympathize with legendary investors such as Warren Buffett, Peter Lynch and others that steadfastly encourage us to ignore macroeconomic forecasts, which they believe as I do, are virtually impossible to accurately predict anyway. Instead, I focus my attention on trying to understand as much as I can about the specific business I am looking at, and its individual and unique prospects for future growth.
To put this in more simple terms, it may or may not be true that the future growth of our economy might, in fact, fall from a traditional 3% to 4% growth rate, to a lower 2% to 3% growth rate. However, it will also be true that many companies will continue to enjoy very fast individual rates of growth in spite of a slowing economy, if it were to become a true prophecy. Consequently, this article will be the first in a series of articles looking at individual growth stocks with significantly above-average prospects for growth.
Another thing that continuously frustrates me about the investment industry is how imprecise it can be with its definitions of important terms. A second frustration of mine comes from the muddy labels behind the application of statistical analysis based on faulty or inaccurate descriptions of important terms and concepts. For example, the over-generalizing of equity investing into either value investing or growth investing. I feel that this is one of the most abused and misunderstood concepts of investing in common stocks that is also prolifically written about and debated.
To put this into perspective, there is a famous Warren Buffett quote where the “Oracle of Omaha” emphatically states that “growth and value investing are joined at the hip.” He goes on to explain that he would never invest in any company that he didn’t believe would grow, and that he would never be willing to pay more than it’s currently worth. It’s further alleged that based on this quote, the venerable investor, Peter Lynch, developed a hybrid strategy known as Growth At a Reasonable Price, or more commonly known as GARP.
Since this article is concerned with growth stocks, I intend to be very precise in how I define a growth stock. In fact, I will offer several definitions in order to clarify the concept of what a growth stock actually is.
If a company shows a history of consistently or regularly increasing earnings, then in the strictest sense, it can be called a growth stock. This would be true whether it grew at 1%, 5%, 10%, 15%, 20%, 30% or more. As long as earnings are growing, no matter what the rate, the company is by the strictest definition a growth stock because the business is growing. Obviously, 1% or 2% growth rates are not what people normally imagine when they think of a growth stock. Most people would envision much faster rates of growth, but the fact is that growth is growth no matter how fast or slow.
Therefore, in order to add precision to the concept of what a growth stock is, I will break the category down into several sub definitions based on each specific company’s rate of earnings growth. The purpose of this exercise will be to illustrate how vastly different growth stocks can be. Hopefully, this will illuminate the truth behind how unfair it is to lump them all into one broad basket. Not only is it true that all growth stocks are not the same, but the magnitude of the differences are truly profound. The power of compounding at higher growth rates produces extraordinary differences in shareholder returns.
Now, here is the most important part of clarifying the definition of a growth stock. In my mind, the true definition of a growth stock has little or nothing to do with its stock price movement. Stock price movements are side effects of what true growth is really about. When I speak of growth stocks, I am talking about businesses that are capable of consistently increasing their earnings at various rates of growth. I will categorize them based on both their historical and future prospects for growth. But generally speaking, a true growth stock, at all levels of growth, is defined as a company that generates shareholder value through a mostly consistent growth of their profits (earnings). In other words, it is the growth of the business that I’m concerned with.
Growth Stocks Defined
The major categories of growth stocks can be broken down as follows: I define companies growing earnings at rates of 5% per annum or less, as slow growth, or low growth stocks. Most utilities fall into this category. Faster growing companies that grow their earnings from 5% to 15% per annum I define as moderate growth stocks. Most blue-chip dividend stalwarts such as The Coca-Cola Company (NYSE:KO), 3M Co (NYSE:MMM), The Procter & Gamble Company (NYSE:PG), etc. will be found here. Very fast growing companies that grow their earnings 15% to 25%, I will define as fast growers. Super-fast or hyper-growth stocks will be defined as any that can consistently grow at rates of 25% or