Friday, June 4, 2010

Growth & Investor Returns

I've revisited the "growth myth" from time to time. Stocks with high growth prospects are routinely given huge multiples of earnings until that growth becomes more subdued. At that point, the multiple collapses and it's look out below.

"Obvious prospects for physical growth in a business do not translate into obvious profits for investors." - Benjamin Graham

In the long run it is durable return on capital and the price that you pay relative to intrinsic value that matters...not necessarily growth. Now, it's true that growth will often have a favorable impact on value. 

It just happens to be a mistake to think that it always has a favorable impact. 

In fact, growth can actually reduce value if it requires capital inputs in excess of the discounted value of the cash that will be generated over time. Sometimes, the highest growth opportunities attract lost of capable competition and capital that ruins the long run economics. Sometimes, high growth requires expensive yet necessary capital raising that dilutes existing shareholders and reduces per share returns.

Finally, even if growth that materializes does have favorable economics, some investors tend to pay a large premium upfront for those growth prospects. That hefty price paid may turn attractive long-term business results into not so attractive investment results.

Adam

Related posts:
Buffett on "The Prototype Of A Dream Business" - Sep 2009
High Growth Doesn't Equal High Investor Returns - Jul 2009
The Growth Myth Revisited - Jul 2009
The Growth Myth - Jun 2009
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