Growth AND Value - Where More IS Better

When I was playing a lot of golf my golf coach would always make fun of the fact that when I made a change to my golf swing or setup that improved my game I would naturally and unconsciously do more of the change which would ultimately result in disaster.  There was a tipping point when a small change was good but more was not better!  I can still hear his words ringing in my ears "More is not better!" 

This tip could be taken to a number of places and in most cases finance is one of them.  Buying more of a losing stock is one example as all that more did was lose you more money.  Adding more risk to an already risky investment is not better and neither is adding more debt to an otherwise overly levered investment.  One place where it does ring true however is finding stocks with better growth prospects than its peers and having more value.  Also if you add the two together; doubly more is doubly better (I know poor English but I could not resist).

Typically investors look for value stocks or growth stocks but it is only when you find a deep value stock that has extraordinary growth prospects then you truly have a home run.  The idea of diversification is to scatter money around so that you might get lucky and hit one of these but this waters down the overall returns which is why people search for these stocks all their lives.  I have found a few of these in my life and let me tell you they will exceed your wildest expectations of returns.  The hardest part is not selling too early but that is the art.  The science is finding these stocks.

Now before you get too excited I am not about to tell you the names of these companies for the simple reason that since finding DDD I have yet to find another one.  If I do I will let you in on the secret but until then it is your job to search for the next one (and let me know) and believe me it is not easy and I have found that luck often plays a part.  Take for example one fortuitous day when I met the CEO of Encore Capital, a local company in San Diego.  Carl was an incredibly detailed person and he had the company whipped into shape during his tenure as the turnaround expert.  The market capitalization as represented by the stock price was languishing at a third of cash flow.  That is right, you could have purchased the entire company using only one third of one year's cash flows.  The market had forgotten about this company.  It was a deep value stock.

Now for those of you searching for deep value (as I have done most of my life) you will often times find that the stock price does not move for years.  It remains deep value forever and you are not rewarded for your wonderful find.  The reason for this is that while it may be a safe investment that is producing significant cash flow, the growth prospects do not warrant a premium over the market and for this reason it sits, stuck as a deep value stock forever, increasing in value slowly over time as the cash position improves.  Holding this position results in opportunity costs and selling is hard because you are sure that the moment you sell it will take off.  The result is lackluster performance.

Now Encore at the time was not only a deep value play but its growth prospects were huge.  The market for their products was expanding and with it Encore's prospects.  I therefore loaded up on as much of their stock as was possible without moving the price of the share and then once I was filled sat back and waited.  Now as its growth started to accelerate right as I was buying it did not take long for the market to wake up to this fact and within 18 months the stock had appreciated by 1,500%!

So when you look for stocks make sure that you are digging around not only for value but also for growth.  Value without growth often lags the market and growth without value increases the risk of the investment tremendously.  Growth stocks can trade at price to earnings multiples in the hundreds as investors drive the stock into orbit expecting the growth to continue forever.  The risk is that once the company fails to grow as quickly, not only does the stock take a hit from the reduced profitability but also from the narrowing of the multiple - a double whammy which shows the risk inherent in buying a growth stock when it has already left the starting blocks.  You need to jump on the bandwagon early and this is why a search for value plays is necessary even if you are an inherent growth investor.

Finding a deep value stock with growth prospects is thus the best possible way to minimize the risk of the investment and maximize the return.  This will require a lot of patience as I would be surprised if you manage to find more than 20 in your lifetime.  I say that not to scare you away from looking but to let you know that the market is relatively efficient and will more often than not reward these stocks well before you find them.  I also mention it because if you work hard enough at it and then find one, do not hesitate but back up the truck and load as much on board as you can as this will be a life changing investment.