Most Popular ArticlesWhat is "Growth" Investing?
Thornburg Investment Management
Alexander M.V. Motola
February 24, 2010
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The most general definition is that growth investing involves purchasing stock in companies that are growing either in excess of gdp growth or faster than the group “average.” Growth investors typically focus first on the business – growth rates, profitability, etc. Value investors usually focus first on the investment instrument – valuation – before moving their focus to the underlying business. The execution at the heart of “growth” investing varies widely. Some investors feel that rapidly growing companies should be bought solely on the basis of their growth, arguing that valuation matters little or not at all, and that the rapid growth and success of the company ensures a good return as an investor. Some, but not all, of this type of growth investor feel that technical analysis is predictive. At the risk of turning this article into a Warren Buffett analysis, it is interesting how his investment process has evolved over time. Without a doubt, the Warren Buffett of the 1950s was a pure value investor (“I’m 15 percent Fisher and 85 percent Benjamin Graham.”). Of course, even that early reference to Phil Fisher (credited generally as one of the earliest growth stock investors; he wrote Common Stocks and Uncommon Profits and was famed for buying Motorola at the ipo and holding for 49 years – until his death) was a harbinger of things to come. By 1972, with the encouragement of Charlie Munger, Buffett was paying a premium to buy a truly great brand: See’s Candies. Buying brands at a premium (believing that as the businesses grew over time, excess capital returns would come in the future) continued from there: Dairy Queen in 1997, Coca-Cola, Fruit of the Loom (in spite of the original Berkshire foray), Benjamin Moore Paints, the list goes on. Instead of being 85% Graham, Buffet is now quoted as saying “Growth and Value investing are joined at the hip” – also implying there is no theoretical difference between the two approaches. Almost two years ago, a paper presented by the academic community analyzed Buffet’s investment history in detail. According to the authors, “Contrary to the popular characterization of Buffett as ‘value investor’ we find Berkshire Hathaway’s investments are more consistent with a large-cap growth approach when using the Fama & French 2x3 size and book-to-market classification scheme. Interestingly, Buffett objects to such a ‘value versus growth’ characterization of investment style because of the inextricable link between value and growth. A growth stock can still be a ‘value’ purchase as long as the intrinsic value is higher than the market price.” In many ways, that last quote gets to the heart of the matter. In the aftermath of the dot-com implosion, growth investing was given a bad name by its most aggressive practitioners. Many myths persist about growth investing, including high turnover, disregard for valuation, the use of technical analysis, and optimism of the kind generally ascribed to Dr. Pangloss. What does “growth investing” mean to the team at Thornburg? Turnover is generally mentioned with a negative connotation. Traders do it, investors don’t. It has tax consequences. It creates “friction,” the aggregate cost of commissions and the market impact of the trade. I would generally disagree that turnover is bad, in and of itself. To borrow from Buffett (his shadow is inescapable), if Mr. Market is going to offer us an attractive price for a business we own, we are going to sell it. Selling at full value is an important aspect of our investing discipline and it allows us to reinvest the proceeds in a better risk/reward (usually cheaper) opportunity. A tax event is created. Taxes can and should be managed, and we do that. It does create “friction” and that is an important consideration in any transaction. But the cost of the transaction is dwarfed by the cost of owning a highly valued security. Buffett has already, to some extent, debunked the idea that the style is dominated by “Growth At Any Price.” Without a doubt, there are investors who worship at that altar, although I imagine the popping of the dot-com bubble and the liquidity crisis of 2008 combined to put many out of the market, or out of business. Any serious investor considers the amount they are paying relative to what they are receiving for that investment. There is substantial academic and empirical evidence to support the idea that valuation is a meaningful component of excess returns. That said, “valuation” often implies a precision that simply doesn’t exist. After all, it is well documented by now how accurate appraisals were in the residential real estate market. I’ve seen home appraisals “accurate” to the hundreds of dollars. Valuation is truly a multi-faceted concept which encompasses many different components. We value every business we invest in. The 50s-era Buffett would have spent time on the balance sheet, in detail. The 70s-era Buffett would have looked there, but moved on to the value of management, the brand, and then generated some idea of the future value of the business – the excess capital returns it might continue to generate. That’s growth investing. Technical analysis is a tool used mostly by traders and momentum-oriented investors. Academic evidence provides almost no support for the merits of technical analysis, with the exception of relative strength. There is clearly some persistency to stock price movements. It’s likely that there are investors who use it to positive effect, but for practitioners who model financial statements and visit management teams, the incremental value to decision making is de minimis. As the saying goes, “All the ships at the bottom of the ocean had a chart.” Growth investing centers around the future. You want your investments to work, so you want a certain, more positive future. Many growth investors featured on cnbc and other media outlets are boundlessly optimistic about the future, and it’s easy to see how this could leave a bad taste in the mouths of some. We approach the future differently. Firstly, we accept that if we are right 60% of the time about stocks, we will be very successful as investors and outperform the vast majority of our peers. That does mean that we are wrong 40% of the time and so must be open to new information that disproves our investment thesis for any individual holding. Because we are investing in entities that are growing and we believe in our ability to select winning stocks, we focus on what can go wrong, not what is going right. One of my earliest professional mentors often advised his analysts “Focus on controlling the downside exposure; let the upside take care of itself.” If we focus on reducing our downside risk in the portfolio, very few things have to go right for us to have a great year. As far as approaches go, it is more “hope for the best, but expect the worst,” instead of “only seeing the rose and not the thorns.” Growth and Value investing are indeed tied at the hip. Voltaire predated Wall Street when he wrote “Common sense is not so common,” but it clearly applies. As we have learned repeatedly through time, common sense has considerable value in the capital markets, but it is underappreciated as an investing trait. Investing means many different things to different people and there are many successful approaches to investing. Even within the Growth “style”, there are many differing philosophies. Our goal in regard to investing in growth stocks is to use a disciplined approach that encompasses elements we feel strongly lead to success: valuation, intensive research, modeling, company visits, and common sense. The views expressed by Mr. Motola reflect his professional opinion and should not be considered buy or sell recommendations. These views are subject to change. Gerald S. Martin and John Puthenpurackal, “Imitation is the Sincerest Form of Flattery: Warren Buffett and Berkshire Hathaway” (April 15, 2008). Available at SSRN: http://ssrn.com/abstract=806246. Buffett the investor is very different than the image of Buffett – and this paper touches on this briefly. Besides just “buying stocks for the long run” as he advises others to do, he is actively involved in more complex capital structure transactions, arbitrage, commodity and currency speculation, and using derivatives.
(c) Thornburg Investment Management
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