Growth At A Reasonable Price

Value Vs. Growth Investing – There are two basic rationales most investors apply when buying a stock. A value investor buys stocks that are trading at depressed levels compared to other stocks with similar characteristics. Value stocks usually have beaten down prices because of recent poor operating results or a gloomy outlook. Sometimes stocks are punished too much for negative results and thus creates a bargain for value investors. A growth investor buys stocks with the expectation that the company will continue to grow its profits and is willing to pay for a higher earnings multiple in the hopes the stock will grow into its current valuation.

We align ourselves more closely with the growth camp because we feel that value is determined more so by growth than anything else. In other words, growth is the largest component in the value equation. A company with a strong balance sheet may look cheap on paper by having attractive price to book, debt to equity, and cash per share numbers but if the company does not have any prospect for growth we don’t think it is particularly valuable to the individual investor. In such a case, there would be no upside potential but much downside risk because common stock holders stand last in line should the company go bankrupt and be liquidated. The best hope an individual investor has in buying shares in such a company is that it is acquired by another company that is attracted by its low market value. This strategy is employed by some who seek to gain from the premium over the current stock price that is normally paid in an acquisition. We don’t buy stocks just for the value of their assets or their small dividends. We buy stocks to share in ownership of their future profits.

Although we focus on growth, we will not buy stocks with extremely high valuations. Generally, the fastest growing stocks are young companies, many of which have not yet reached profitability. The marketplace often puts a demand on shares of new high-flyers in hopes they will turn out to be the next Microsoft, Cisco, or Google. Our model generally does not value these stocks as richly as the marketplace because we are not as confident in long term growth projections as the marketplace. This is especially true after the tech wreck of 2000-2002. Another reason you won’t find many start-ups in our portfolios is that we require a consistent profit growth pattern to be in place. The best way to describe our position on the growth/value debate is “growth at a reasonable price” (GARP). The GARP concept has become popular in recent years among analysts. We feel true value is determined by future profit growth but we are not willing to pay a sky high valuation in hopes a stock can continue its rapid profit expansion and grow into a more modest value.