“Sometimes it’s helpful not to look at valuations too closely. Just blur your eye and say ‘I see a big future for these stocks’”                                Henry Blodget

Growth stocks are exciting. How many times have you heard from some people that if you want to make big money, if you want to be a super investor, you must buy stocks with high growth? So does it follow that a strategy of investing in stocks with high growth rates will deliver high returns?

Microsoft, a high growth stock

Let us look at a great company in the United States, Microsoft Corporation. In December 2000, Microsoft was trading at around RM59.00, at a PE ratio of 84, with a earnings per share (EPS) of 70 sen then. In the seven years leading to 1999, Microsoft’s EPS has grown by 775%, or a compounded annual growth rate (CAGR) of 34%. That high PE ratio for such a high growth company was logical, wasn’t it? Microsoft was such a high growth company, and it was also at the peak of euphoria of internet stocks. Aren’t you always asked to buy and chase stocks during hot period, momentum play? Microsoft’s EPS was $2.63 for the last twelve months ending 30^th September 2014, or an increase of 276% since 14 years ago. It is still a fantastic CAGR of 10%. I doubt you can find many companies like this with this type of CAGR. Microsoft is trading at $48.79 now. Its share price is still 17% below what it was 14 years ago, despite that its share price has risen by about 200% since the US sublime crisis 5 years ago.

The August 2000 issue of Fortune Magazine included an article titled “10 Stocks to Last the Decade.” The recommended stocks (which were described as “Here’s a buy-and-forget portfolio” that would let you “Retire when ready”) suffered  an average loss of 80% at the end of 2002. Some have gone into oblivion like Enron, Nokia, and none of them have recovered to their previous prices as at now. Sure, investors can retire when you are 80 years old, and by eating Maggie mee everyday.

High growth stocks in Bursa

Let us look at our own backyard and some of the high growth stocks mentioned in my favourite article here again:

http://klse.i3investor.com/blogs/kcchongnz/45373.jsp

There were nine stocks mentioned in the above article, and I can see at least 6 of them can be considered to have very high expected growth.

1. KNM, the shining star

Do you know something about KNM? Its growth for the last ten years outpaced Microsoft, an international conglomerate. KNM’s revenue grew by 30 folds from less than RM65m in 2003 to a RM2 billion revenue company now. The CAGR is a whopping 41%. I bet you can’t find one in Bursa that grows at this rate for the last 10 years.

Do you know something else? Tell you a secrete. Although its net income did not grow in tandem, it has never lost any money in any year since its listing before!

What happen to its share price? It has dropped from more than RM10 ten years ago to just 72.5 sen now, not RM72.5. What happened to this extremely high growth company?

2. London Biscuits Berhad, the flamboyant star

LonBis’s growth is also very high. It’s revenue grew by 3.4 times since 9 years ago from RM82m to RM360m as at 30^th June 2014. It’s earnings, as that of KNM, has not been very exciting, but it also has never lost any money since listing. It is another wonderful company, isn’t it?

What happened to its share price? It has dropped from a peak of more than RM2.50 since then to just 73 sen now. But why not RM7.30 instead for such a high growth company?

3. Guan Chong Berhad, the chocolate delight

Guan Chong’s revenue grew from about 500m 5 years ago to 1.44b in 2012, or a CAGR of 24%. This is another billion dollar club member. What a fantastic growth stock. its profit also grew in tandem from 1.4 sen per share to 8.2 sen, or a CAGR of 56%. Investors who have invested in it years ago did very well indeed. When someone asked me about this stock when its share price was about RM1.80 about two years ago in i3investor, I said it was better to avoid it. I was scared to death about the quality of its earnings. Since then its share price has retreated to just RM1.09 now. What happen to this high growth stock?

4. Hibiscus, the gushing well

If you keep track on the number of licenses and concessions Hibiscus secured to explore oil all over the world a year ago, you would probably pay any amount for its share then. Yes, that was exactly what happened. Hibiscus share price was chased up by 80% from RM1.50 to RM2.70 in just four months from August to December 2013. Thanks to this special-breed Dr Kennet who was offered a stake in a top-notched drilling company cheaply, to him, him only and not others,  and he out beat the smartest oil and gas people in the world to obtain this and that concessions all over the world, presumably Hibiscus is more deserving than many international oil exploration companies. It’s share price has dropped by 61% from the peak of RM2.80 to RM1.10 now, in less than a year. Why not RM11.00 now? What happen to the share price of this expected high growth company?

https://www.youtube.com/watch?v=F1gC8zYrbQ4

5. Asia Media

My favourite analyst, Phillip Capital (PC) made a strong recommendation to invest in Asia Media in mid 2011. Don’t get me wrong, my classmate, a well known and reputable analyst, is the chief investment officer there and I think PC is one of the best performing fund managers now. A number of other analysts also strongly recommended it as it was expected that its growth in its advertising business in the trains, MRT, LRT, buses etc would explode and the sky is the limit for its business model. At 8 sen now, not 80 sen, its share price is not even half of the adjusted price then. Again what happen to this high expected growth company?

6. Smartag (SMTrack)

Smartag’s growth was expected to be ultra high when it was anticipated that the Royal Customs Department would give them the ultra lucrative contracts of RFID tracking the containers three years ago. It was trading at more than 40 sen a share then, and still shouting cheap cheap. Its share price is just 11.5 sen now. So is it a smart move to invest in an expected high growth company like this Stupidtag? Actually the management realize their folly and has changed the name to SMTrack.

Value of Growth

Actually there is no issue about growth,. Generally, a firm with a higher growth will grow its earnings at an accelerated rate and maximizes shareholder value. There are a few important things to look for though basing on the above examples. It is not just growth, growth, growth, but what is this growth and what is the quality of this growth.

1. Make sure you don’t overpay for growth, as for the example of Microsoft in year 2000. This you must a feel of the value of the stock before you decide to pay a price for it, even for great companies.
2. The growth in revenue must be accompanied by the corresponding growth in earnings as shown in the case of KNM, London biscuits and GCB, or rather not shown.
3. Even growth in earnings is not necessary a good thing. After all a company can borrow another RM1 billion and earns RM10m a year from it, it is only 1% and way below the cost of capital. This is actually happening to all the first three companies mentioned above. They borrow huge amount of money but earn pittance, and their borrowings exploded, not earnings exploded. The return above its costs of capitals is the thing investor should look forward to, not growth in revenue, nor earnings.
4. Make sure the expected growth is not a hope like what happened to Hibiscus, and all new SPACs, Asia Media and SmarTag. Otherwise you would end up with instead a soul full of hope, but a hole full of soap.
5. Make sure you understand what their reported earnings are and their quality. This is an issue for all those stocks mentioned above, without any exception. What a coincidence, or is it?

If you intend to embark on investing for long-term wealth building for retirement, sponsoring children’s education, buying a house etc, it depends not only on how much you can make from the stock market, but equally important is how much you avoid losing getting caught in the bad stocks. Take care of the downside and let the upside takes care of itself should be the motto of your investing strategy. But how are you going to check the above? Can you depend on your remisiers, brokers, investment bankers and analysts’ reports, the hooha in internet investment forums?

For enquiry for a fee based online investment course, you can contact me at

ckc14training2@gmail.com

K C Chong (12^th November 2014)