| |
 |
  |
|
| News Articles Stocks DRPs Brokers Links Free Newsletters |
| Rothery Report: Login Learn More Performance Sample Subscribe Contact Us |
5 Stingy Stocks for 2008
5 Graham Stocks for 2008
Is your index too active?
Graham's Simple Way
Canadian Graham Stocks
5 Stingy Stocks for 2007
8 Graham Stocks for 2007
Top SPPs
The Simple Way
A hole in your IPO?
Monkey Business
8 Stingy Stocks for 2006
Graham Stock Gainers
Blue-Chip Blues
Are Dividends Safe?
SPPs for 2005
Graham's Simplest Way
Selling Graham Stocks
RRSP Money Market Funds
Stingy Stocks for 2005
High Performance Graham
Intelligent Indexing
Unbundling Canadian ETFs
A history of yield
A Dynamic Duo
Canadian Graham Stock
Dividends at Risk
Thrifty Value Stocks
Stocks in Short Supply
The New Dividend
Hunting Goodwill
SPPs for 2003
RRSP: don't panic
Desirable Dividends
Stingy Selections 2003
10 Graham Picks
Growth Eh?
Timing Disaster
Dangerous Diversification
The Coffee Can Portfolio
Down with the dogs
Stingy Selections
Frugal Funds
Graham Revisited
Just Spend It
Ticker Temptation
Stock Mortality
Focus on Fees
SPPs for the Long Term
Seeking Solid Stocks
Relative Strength
The VR Approach
The Irrational Investor
Value Investing
Eye on PI
MoneySense Articles
Small stocks, big profits
Cdn Top 200 2008
US Top 500 2008
Value that sizzles
So simple it works
Income 100
No assembly required
Investing by the book
Cdn Top 200 2007
US Top 500 2007
Invest like the masters
A simple way to get rich
Top Trusts 2006
Stocks for cannibals
Car bites dogs
Cdn Top 200 2006
US Top 1000 2006
So easy, so profitable
Top Trusts 2005
Dogs of the Dow
Top 200 2005
Money for nothing
Yield of dreams
Return of the master
Norm Speaks
Growth is what it's all about for investors. Every investor wants to see their portfolio grow and many attempt to generate wealth by buying growth companies. At first glance, it seems to be a simple matter to buy companies that have grown the most and, therefore, are likely to continue growing. Regrettably, as with many simple investment concepts, selecting growth stocks is fraught with difficulty.
With the view that past equals prologue, let's look at what would have happened to an investor who bought companies that grew the most in the previous year. This is sort of like the Dogs of the Dow approach except that instead of buying good dividend yield the growth investor buys stocks with the largest earnings-per-share growth in the prior year. The investor holds these prior year growers for a year, sells them, and then buys the new crop of growth stocks. How would such an investor have fared? Not including the corrosive impact of taxes, inflation, and commissions this approach was not fruitful from 1952 to 1996 according to James O'Shaughnessy . From 1952 to 1996 the top 10% of earnings-per-share growth stocks returned an annual compound return of 11.92% whereas the lowest 10% of earnings-per-share growth stocks returned 12.02% annually. The average stock did better than either extreme with a 13.35% annual return. Obviously, picking stocks based on one-year earnings-per-share growth was not worthwhile.
Perhaps longer-term growth is more profitable? Thanks again to Mr. O'Shaugnessy we can answer this question by considering the purchase of stocks each year which experienced the best earnings-per-share growth during the past five years. Again the investor swaps stocks each year to hold the latest batch of high growers. From 1952 to 1996 the five-year growth strategy yielded an annual return of 10.80% for the top 10% of growth stocks. On the other hand, the lowest 10% of five-year growers provided a 12.41% return and the average stock 12.91% annually.
What is going on with growth stocks?
To some extent this question is answered in the Tweedy, Browne report Great 10-Year Record = Great Future, Right?. The report takes an academic look at growth investing and I've reproduced two of its startling tables. In Table 1 stocks are placed into ten equal groups. The stocks with the highest past five-year sales growth in group ten and those with the lowest past five-year sales growth in group one. Subsequent five-year sales growth is then determined. Regrettably, a record of past sales growth is only a weak predictor of future sales growth. Turning from sales to earnings, Table 2 provides evidence on earnings-per-share growth. Here past strong earnings-per-share growth is a poor predictor of future earnings growth and poor growth appears to bode well for future growth. With this evidence in hand, it is little wonder that buying past growth turned out to be a poor strategy. Past sales or earnings growth simply does not predict future growth.
So what are we faced with? First, it appears that growth in sales and earnings is not easily predictable. If anything past poor earnings growth appears to indicate better than average future growth. Armed with this knowledge, investors can look with some skepticism on stocks with a strong record of growth. Other investors have probably noticed the growth trend and bid up prices accordingly. With a particularly long record of growth it seems likely that investors become overconfident of a rosy future and prices rise too high. The result is that stocks with a long-term growth record, as a group, tend fare worse than the average stock. In the end, it is better for investors to forget about past growth when selecting stocks.
Tables
| Table 1 | |||||||||
| Does Past Sales Per Share Growth Predict Future Sales Per Share Growth? | |||||||||
| Companies Ranked on Past Sales Per Share Growth Rates, 1967-1991 | |||||||||
| Low | High | ||||||||
| 1 | 2 | 3 | 4 | 5 | 6 | 7 | 8 | 9 | 10 |
| Growth Rate of Sales per share over the past 5 years | |||||||||
| -18.5% | -1.8% | 2.3% | 5.0% | 7.1% | 9.0% | 11.1% | 13.6% | 17.7% | 31.7% |
| Growth Rate of Sales per share over the next 5 years | |||||||||
| 5.7% | 5.2% | 5.4% | 5.5% | 6.3% | 6.9% | 7.4% | 7.8% | 8.9% | 7.7% |
| Source: Tweedy, Browne Company | |||||||||
| Table 2 | |||||||||
| Does Past E.P.S. Growth Predict Future E.P.S. Growth? | |||||||||
| Companies Ranked on Past E.P.S. Growth Rates, 1967-1991 | |||||||||
| Low | High | ||||||||
| 1 | 2 | 3 | 4 | 5 | 6 | 7 | 8 | 9 | 10 |
| Growth Rate of Earnings per share over the past 5 years | |||||||||
| -38.4% | -7.4% | -0.1% | 4.4% | 7.8% | 10.9% | 14.3% | 18.5% | 25.0% | 51.1% |
| Growth Rate of Earnings per share over the next 5 years | |||||||||
| 23.1% | 9.2% | 6.3% | 5.7% | 4.9% | 5.5% | 5.9% | 7.0% | 6.2% | 5.3% |
| Source: Tweedy, Browne Company | |||||||||
Sources
What Works on Wall Street, Revised edition, ISBN 0070482462
Tweedy's reports can be found at http://www.tweedy.com/content.asp?pageref=reports
First published in November 2002.
|
|
| About Legal | Contact Us |
A Dan Hallett and Associates Inc. publication. Norm Rothery, Ph.D., CFA, is the Chief Investment Strategist at Dan Hallett and Associates Inc. (DH&A) and the founder of StingyInvestor.com. DH&A is registered as Investment Counsel in the province of Ontario. Norm, DH&A, or related-parties may have an interest in the securities mentioned. More...