Friday, November 12, 2010

Grantham: High Growth Doesn't Equal High Returns

Here's an excerpt from a good interview with Jeremy Grantham on CNBC yesterday. During the interview he talks about the performance of the developed versus the emerging world.

"If you're going to grow at six [percent]...it is very appealing that you would outperform a world growing at two percent. And the developed world is slowing down...I say it has an incurable case of middle-aged spread.

It's just been there, done that. It's a little old. It's a little pastured. Doesn't have the population profile. Emerging does. And they have the attitude, and they have good finances. And— and they're really showing— a— a clean pair of heels to the developed world.

Now, it turns out that you— it's a bit more complicated. You don't actually find a strong correlation between— top-line GDP growth and making money in the market. It— it seems like you should. The fastest-growing countries should give you the highest return. They simply don't. But, there's only four of us— that— that believe that story. Everyone else in the world believes that if you grow fast like China, you'll outperform in the stock market." 
- Jeremy Grantham

Just another example of growth being of less importance for investor returns than paying the right price for a durable enterprise run by reasonably able managers (those that intelligently allocate capital most of the time).

Basically, buying at a discount what's capable of generating a nice return on capital for a very long time.

Growth, of course, will often have a favorable impact on value. 

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

Growth can, in fact, actually reduce value if it requires excessive amounts of capital relative to the discounted value of the cash 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 costly but necessary capital raising (to fund investments, deal with emerging competitive threats) 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.

Check out the full interview in this video.

Adam

Related posts:
Growth & Investor Returns - Jun 2010
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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