Growing Rich - Arabictrader.com

GROWING RICH WITH GROWTH STOCKS
downside. When prices are going up, it’s great. You want to look for
companies with sustainable earnings growth that are capable of expanding
their multiples even further, since that can generate a double
compounding of your money. “However, it also works in reverse,”
Davis warns. “If you start out with a high multiple, and the earnings
growth rate is reduced, even if it’s still a good number, the lowered
expectation will cause you to get a compression in the multiple. That’s
detrimental to your wealth.”
ASSESSING RISK
One thing every equity investor must figure out is how much pain
he or she is willing to suffer during periods when the market is getting
slammed. “I discovered in the 1970s that a lot of bad things can
happen to you in a bear market,” Davis shares. “If a company has a
weak balance sheet, it will turn into a disaster, since interest rates
usually go up during market declines. As a result, the cost of operating
the business rises and the company needs more money to keep going.
Yet the banks won’t make any new loans, feeling the business is
already inundated with high-priced debt. Therefore, it’s next to impossible
to raise equity. Nothing can kill a company faster than losing
access to money.”
The other thing he realized is that if you own a growth company
for which Wall Street has high expectations, and those expectations
are not met during a bear market, look out below. “You can get a
wicked multiple contraction and see a tremendous exit from the
company when that happens, because there’s not a natural buyer for
the stock,” he says. “You’ll have a stock at 40 times earnings that
falls to 25 times earnings and still isn’t a bargain. That’s because your
natural constituency has moved on to another hot growth company
and there’s no value buyer there to sop it up ‘even’ at 25 times earnings.
Some of these small-cap high-growth companies can languish
for years once a bear market breaks their charm.”
Still, size has never been a big factor in Shelby’s decision-making
process. “I don’t mind large or small, as long as the growth is relatively
predictable, the multiple isn’t too high, and management is doing its
job to build the business in a sensible way,” he contends. “Having
said that, the technology sector is tough because change, in a way,
is your enemy. These companies are spending between 10 and 20
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