Spotting growth stocks

Discovering the hot stocks of tomorrow isn’t only for investment gurus and fund managers. In this book on investing in growth stocks, Michael Moe explains how ordinary investors can do it too, says Kamya Jaiswal.

Kamya Jaiswal        Print Edition: May 15, 2008

Finding The Next Starbucks
Finding The Next Starbucks
Price:
Rs 595
Pages: 374
By: Michael Moe
Published By: Penguin Group
TARGET AUDIENCE: Equity investors
QUICK READ TIP: Don’t miss case study comparisons at the end to learn how Moe’s strategy is used
LANGUAGE: easy
STYLE: Illustrative, Argumentative
VISUALS: Graphs, Tables, Charts
It’s the Holy Grail for all equity investors—the formula for spotting the next Google, or, back home, the next Maruti or Infosys. A rupee invested in the initial public offering (IPO) of Maruti in 2003 is worth about Rs 6 now. That’s the kind of spectacular returns everyone is chasing.

But how do you do it? How can you, an ordinary investor, train your eye to zoom onto a star in the making? Ask this question and you are swamped with advice. Everyone seems to have an investment philosophy to share. Yet no one has a definite answer. Except, perhaps, Michael Moe. At least that’s what he claims in his book with the telling title Finding The Next Starbucks.

Moe’s credentials are impeccable. A research analyst, with Lehman Brothers and Merrill Lynch in his resume, he was among the first to identify golden geese like Starbucks Coffee and Apollo Group and stick on with Google when others had thought the stock had peaked at $200. Of course, analysts like Moe were right—it did so at $742.

From the start, Moe challenges conventional investment intelligence and highlights their shortcomings. To spot a growth company, you should know what qualifies as one. Moe rubbishes parameters such as the growth of a company should be higher than the growth rate of the country’s gross domestic product or that the price to earnings (P/E) ratio of the company should be higher than the market. His criterion: the company’s size. The smaller the company, the faster it is likely to grow.

There is no arbitrary growth rate that qualifies a stock for being on the radar of potential biggies. To narrow the field further, Moe suggests that investors start searching for growth companies in the “sweet spot”, that is companies with low market capitalisation. As proof, he has listed the market capitalisation of the top 10 fastest growing companies of the past two decades at the time of their IPO. All were small caps.

But the mainstay of Moe’s investment philosophy is that the chief driver of stock prices is the rate of growth of a company’s earnings. The entire book is anchored on this belief. If you are convinced that a company can sustain high earnings, Moe says hang on to it. The profile of top American stocks in recent years (provided in a detailed table) justifies this emphasis on earnings.

Moe’s 10 Commandments

For identifying star stocks of tomorrow


• Get the fundamentals of investing right

• Anticipate where the world is heading to choose stocks

• Be rigorous but don’t overanalyse stocks

• When wrong about an investment decision, admit it

• If a company has one problem, it will have more

• Get information but also get insight on how to use it

• To evaluate a company, factor in the people, product, potential and predictability

• Use five independent input sources for each stock

• Find three reasons why the stock will move

• Be passionate about investing but dispassionate about the investment

Putting together these concepts, Moe has devised the 10 commandments of identifying future hot stocks (see box). His approach is top down. Moe identifies eight “megatrends” of the future which will change the social, technological and economic landscape globally. Each trend has a list of industries it will affect. It is at this intersection of trends and industries that Moe looks for companies that can do a Starbucks encore. The companies are evaluated according to the four Ps: people, product, potential and predictability of the company. Based on his strategy, Moe identifies 16 investment areas from where he believes tomorrow’s winners will emerge. He also lists the companies in each investment field to watch out for. At the end of the book, Moe has compared companies within the same industry on the basis of his evaluation techniques.

Further analysis is done by crunching numbers— Moe discusses some popular valuation methodologies such as P/E to growth ratio and price to sales multiple. This section is difficult to understand even though Moe attempts to explain the concepts in “plain English”. However, sophisticated investors who use analytical tools for stock-picking have much to learn. The author marks out seven variables that investors should track for gauging the short-term movement of high-growth stocks.

It is difficult to find fault with this strategy, not because it is Moe who is advocating it but because it appeals to common sense. Moreover, Moe is very thorough. When he is discussing a megatrend, for instance the knowledge economy, he provides statistics ranging from the fastest growing occupations in the US to a flowchart of the “Human Capital Value Chain” describing how talent will be at the centre of the knowledge economy.

The reader is always on Moe’s mind. He realises that simply listing the parameters, the four Ps, is not enough. So after each of them is a list of questions investors must ask while evaluating the long-term potential of a stock on the particular criterion.

Moe’s arguments are cogent and language lucid. The book is peppered with personal anecdotes, quotes from investment gurus and excerpts from Moe’s interviews with the who’s who of business and investing, such as the founder and CEO of Starbucks, Howard Schultz and venture capitalist Vinod Khosla.

In the introduction of the book, Moe says that you don’t have to be a Warren Buffett or Peter Lynch to spot growth companies. True, but you sure need to think like them. All investors hoping to join the league, don’t miss out on this book.

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