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"The Risk Of Low Growth Stocks"


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Interesting posts about the large impact that small differences in growth rates for slow-growers can have on intrinsic value (more than we might intuitively guess at):

 

Part 1: https://intrinsicinvesting.com/2019/02/22/the-risk-of-low-growth-stocks/

 

Part 2: https://intrinsicinvesting.com/2019/02/27/the-risk-of-low-growth-stocks-part-2-prestige-brands-case-study/

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A related point is that, mathematically, IV becomes more sensitive to small changes in growth rates as interest rates go down.  For example if your discount rate is 10%, reducing growth from 3% to 2% results in a 1/8 reduction in IV, whereas if your discount rate is 5% the same reduction in growth results in a much larger 1/3 reduction in IV. 

 

If people were surprised by what the blog is discussing, it may be because they were relying on their financial intuition that they developed back when interest rates were somewhat higher. 

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Reading this article makes me thing we are in some alternative universe with yearly rises of growth well above 5% for the last few years for many companies. I am almost not aware of any stocks I own or follow that has posted negative growth in the last few years (except a few contracting or broken situations). This seems to be quite strange given the long term historical record.

 

I'm also reminded when he says "The value of a stock is nothing more than the value of the future cash flows that the company will produce," what Philip Fischer said that this may be so but that the price of a stock is almost always based on expectations. Which is why a great company with a good value can swing very savagely when these expectations change. This may be rare , but can happen anytime.

 

I've also noticed that PE ratio and growth rate have an intangible component which is the belief in the moat of that business. While I don't necessarily agree that say Verisign or Lindt Chocolate should have 30 to 40x p/e ratios for their quite modest growth rates, I do agree that the franchise and moat are incredibly strong, producing a higher valuation for the same growth rate as another company having the same metrics. In a market crash, smart people still tend to go for the quality business, or sell out an inferior business to move up the quality chain. Just like going for the US dollar or gold. These assets tend to have an unfair advantage above and beyond their absolute potential.

 

 

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  • 4 weeks later...

The problem I have with this analysis is that its based on the least predictable and reliable signal...growth. Also why even focus on growth....if you really want big money why not just focus on market timing. If you could predict the high and lows of stocks your returns would even be higher than if you could predict growth. At one time Blackberry was a growth stock :)

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Looking at part 2 again , the chart at the bottom, his 'required fcf yield seems way too low. I mean he starts with required yield of 4% at 5% growth and goes to 8% at 1% growth. That means FCF multiples range from 25x to 12x. I have seen several dynamic companies at 25x FCF with growth rates higher than 5%. It's true he is assuming perpetual growth rates but between now and perpetual can be a a decade or two before the higher growth rate meets the perpetual rate. That period of time is one where the stock price would be growing not contracting.

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The problem I have with this analysis is that its based on the least predictable and reliable signal...growth. Also why even focus on growth....if you really want big money why not just focus on market timing. If you could predict the high and lows of stocks your returns would even be higher than if you could predict growth. At one time Blackberry was a growth stock :)

 

I don't think that's what they're doing. Did you read the articles?

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