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Don't Fight The Future (Cestrian Stocks Bulletin #64)

Cestrian Stocks Bulletin
Don't Fight The Future (Cestrian Stocks Bulletin #64)
By Cestrian Capital Research, Inc • Issue #64 • View online
Why growth is usually the best long-term investment strategy. (Other strategies are also available).

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Don't Fight The Future
Very broadly in long-term investing there are two approaches, as you know. Value, and growth. Each can work; you shouldn’t have religion on this, you should just do what makes you the most money. In our long experience as investors, growth has proven to be the more successful approach. Here’s why.
Value
To draw very simple differences between the two, value investing generally focuses on buying stocks in companies valued at low price to earnings ratios, usually with substantial dividend yields. The notion here is that you protect your capital by not over-paying on day one, and you grow your capital as a result of dividends coming back into your account to be redeployed into likely the same stock at the prevailing price (your regular dividend reinvestment program) in addition to any improvement in the stock price that the market may generate. If you have picked the right company, says the value bible, then as its earnings improve over time so will its stock price.
Now, value investing is not to be sneezed at and there are many stocks even in today’s growth-addled market where the value approach is likely to work out well. We ourselves own AT&T ($T) in staff personal accounts for exactly this reason. We bought a sizable allocation when the stock cratered recently, and hope to pick up around a 6-7% dividend yield as measured with our in-price of the stock as the denominator. In addition we think the stock can reprice upwards once demerger noise settles. Fit and forget, sleep easy, no issues. If all we make on that investment is 5-10% per year over a long run period, well, that’s just fine thankyou. We also own a basket of old-line defense names - your Lockheed Martins ($LMT), Northrop Grummans ($NOC), and so forth. We don’t expect them to reach for the sky anytime soon; we do expect a modest dividend stream, slow but steady long run share price growth and, in particular, a hedge for those times when the many growth stocks we own dive headlong into the inevitable-but-usually-escapable abyss.
Growth
Growth investing is all about picking the right company, and less about perfect timing. The growth religion exhorts you to be less price sensitive than in value names, because if you pick the entry point unwisely, the revenue and earnings growth will probably come to your rescue if you have the patience.
Companies that qualify as growth names deliver consistent revenue increases of say 15-20% plus per year (there’s no hard and fast rule, but sub 10% you might consider value, above 20% you might consider growth). This is important because GDP growth in most developed economies averages maybe 1-4% per year over the long run. Right now in the post Covid rebound we are seeing higher rates than this, but this is just, to borrow an over-used word, transitory. So if you can find companies growing at more than say 5x the rate of the economy, consistently over a long period, they’re likely to prove to be good investments. So far so obvious. The issue people have with growth investing is that it seems there are never any bargains in growth. In public stocks at least, it’s easy to conclude that growth names are always expensive with all the upside already priced in. You see comments of this nature everywhere in the market, all the time. In truth, that’s lazy as well as incorrect. It’s easy to say, huh, crazy price, it’s hard to say, well, that price looks crazy but I’m going to buy the stock anyway because I believe that between the prospects of the company itself, and the way the market will likely value its stock over the period of years I plan to own it, I can make a solid investment return. This is the hard work that we do.
Speaking for ourselves here at Cestrian, the bulk of the capital in staff personal accounts is held in growth stocks. That’s partly because we do the work on each and every name, in a quest to understand the industry dynamics facing each of them, to dive deep into the business model and financial reports of each of them in order to gain confidence that way (for more on this topic, read our post on cloud stock pricing here). But it’s also because we try to keep an open mind about new, new things. You’ve heard the phrase, don’t fight the Fed? Well, we have another one for you. Don’t fight the future. What we mean by this is, it’s easy - and lazy - to dismiss new trends that lie behind growth stocks. It’s easy, and lazy, to say, huh, that’s just a fad, it’ll never catch on; or, huh, that’s a short term trend that will blow over, it’s too late to invest in it now, or, huh, that’s just like Company X from Days of Yore, I don’t think I’ll bother. But new trends aren’t something flighty and frivolous - new trends are core to human nature. Since the first sea-creature said, hm, wonder what that land stuff is over there, think I’ll swim up and take a look, OK, better grow some legs - living things are always trying to move up and to the right, humans more than most. It’s the same driver that leads to population growth, geographic expansion, improving transport technology, improving communications technology and so forth. And just because you personally think, well, why do I need to be able to put rabbit ears on a photo of myself without having to actually draw rabbit ears ($SNAP), doesn’t mean that the company whose stock you are considering doesn’t have a large army of customers that want to do exactly the thing that puzzles you, and likely more besides. If you do the work rather than just dismiss the new thing, you’ll likely learn something and put yourself in the position to make money from growth stocks - if you just dismiss the new stuff, then, not so much.
Here’s an example from our own history. When Facebook ($FB) first started growing in popularity pre-IPO, our take was twofold. One, it’s just Friendster or MySpace done over again, yawn, or, to be still more reductionist, it’s Microsoft FrontPage but you don’t need to load a CD into your PC. (If you’re under 35 you can Google “FrontPage” and also “CD” and “PC”). And so we initially dismissed it. But then we did the work, learned about what a social graph was, learned about how social media uses the Hook Model to keep you coming back for more shots of dopamine, learned about why all this is gold for advertisers, understood that meant huge margins whilst also growing fast, whereupon we concluded that, well, neither FrontPage nor Friendster nor MySpace was anything like that and that in fact Zuckerberg was a kind of genius.
In our growth stock coverage here in Growth Investor Pro, our first assumption is to believe in the future, because the one thing about the future is, it’s going to happen, and the second thing is, it won’t be like the present. If we see investable themes driven by youngsters’ consumer or workplace behavior, we want to play those themes if we can find a compelling way to do so. This is why we are so excited about Metaverse opportunities - we have no plans to buy any AR / VR kit nor to start building virtual worlds - the products and services are of no interest to us personally but we think they are going to pique a lot of folks’ interest and that this will lead to outsize revenue growth in the key names. Because we are old, we can easily say, oh, Metaverse, that’s just a Second Life reboot, that’s so like 2003. But that’s like saying that an iPhone is a lot like an Apple Newton, which is to say, it isn’t.
So you will see us questioning numbers, growth rates, why margins are good or bad, why the management team did or did not do or say something on earnings calls, but you won’t see us saying, why on earth would people want to do X? We think that but that’s just because of our age and curmudgeonliness. What we think is a good way to spend time is irrelevant to investment performance. As far as investing goes, we are, and intend to remain, dead inside, and we exhort you to be the same.
Cestrian Capital Research, Inc - 9 September 2021.
This article first appeared in Growth Investor Pro.
DISCLOSURE - Cestrian Capital Research, Inc staff personal accounts hold long positions in a great many growth stocks together with LMT, NOC and T.
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