[The Weekend Bulletin] #53: The Growth Conundrum (Growth vs ROIC vs Valuations)
+ Zombie Companies, Being Creative, Gaming Industry and more…
A digest of some interesting reading material from around the world-wide-web. Your weekly dose of multi-disciplinary reading.
Section 1: Investing Wisdom
Through numerous articles over the last few weeks, we have been studying the importance of growth and ROIC (return on invested capital) for long term compounding of business value. While the general conclusion is that both growth and ROIC matter for long term returns, if the investor had to choose any one between the two, what would it be? This article provides a data-backed answer.
If growth fades eventually, as the above article demonstrates, then why is it still considered as an important factor in long term value creation? Why not just focus only on ROIC instead? For two reasons, as listed below:
While it is true that growth fades eventually, this generalisation masks an important naucne - valuation. Stated simply, valuations reflect the general expectations of the crowd. And while the crowd is well aware that growth fades eventually, it is not easy to estimate when that eventuality will occur. Of course, empirically, high growth phases have lasted, on average, for around five to ten years.
“Investors tend not to believe in “longevity of compound.” Conventional thinking has it that good things do not last, and indeed, on average that’s right! Empirical Research Partners, an investment research boutique, discovered that the chance of a growth stock keeping its status as a growth stock for five years is one in five, and for ten years just one in ten. On average, companies fail.”
- Nicholas Sleep
Thus, the crowd generally builds this in their valuation model. Some companies, however, defy this norm and continue to grow for far longer than the crowd can optimistically estimate. Such companies go on to create serious long term wealth for investors as the growth surprises lead to periodic valuation re-rating (thus investors enjoy the double benefit of extended growth and increasing valuations). This is one of the reasons why growth rates matter. But how does an investor identify, in advance, which companies will continue to grow longer than estimated? This article attempts to answer this question by reviewing four models that can help companies continue on the path of high growth.
Further, the answer to the question that should investors ignore growth and focus only on ROIC, since the former eventually fades is ‘depends’. The relationship between growth and ROIC is not as simple as it seems. As this McKinsey article elaborates, the current growth-ROIC relationship of a company defines what it should focus on in the future. Some companies have more leeway to sacrifice growth in favour of ROIC, while some don’t. This understanding will help investors to identify the right corporate strategy to invest in for the most optimal long term returns.
No discussion on growth would be complete without talking about valuations. Given the stupendous performance of growth stocks, investors remain divided on the right approach to investing in growth stocks. Some investors believe in the GAAP (Growth At Any Price) philosophy while those with a value bent are still promoting the GARP (Growth At a Reasonable Price) philosophy (albeit from the sidelines). While we’ll know which one worked better only with the benefit of hindsight a few years (or decades!) down the line. In the meantime, we can only look at history and wonder if it’ll repeat, like the author of this article does.
If all of the above left you scratching your head, need I remind you that ‘Investing is Simple, But not Easy’ 😇.
Section 2: Mental Models & Behavioral Biases
Second Order Effects - consequences of consequences - is, to me, one of the most intriguing mental models - for it is not only surprising to understand how much things are interlinked, but often amusing (entertaining even) to see the indirect consequences of decisions. This article looks at the second (or third?) order effects of decades of low interest rates on the economy. It highlights how low interest rates have given rise to Zombie companies, and how these companies are impacting GDP growth which in turn tells us about where we are in an economic super-cycle. A very interesting read indeed, but not of the entertaining variety.
Section 3: Personal Development
Technology is a rising threat to the modern worker. It is either replacing low skilled jobs with lines of codes, or it is increasing competition in the job market by blurring geographical boundaries. Thus, in order to survive and thrive in the internet age, it is imperative that the modern worker hone skills that are not easily replaceable i.e. find creative pursuits within one’s domain.
The problem is that we hold creativity in our minds as a domain reserved for the gifted few. Our general perception of creative people is them being geniuses and weirdos at the same time. We picture them as people who are extremely gifted, and who defy the conventional norms. This article debunks these myths by arguing that creativity, in reality, is hard work. Thus, through some degree of routine and repeatability, creativity can be accessible to the general masses.
Below are some interesting observations made by the article:
Creative people don’t “find time” to be creative—they put in the time to be creative: It turns out that the secret to the creative “greats” throughout history is less that they were creative geniuses and more that they were work-ethic geniuses.
Normal actions with extra-ordinary intentions: Most of the internet would have you believe that boring, stable jobs somehow kill creativity. But in many cases, the boring corporate life actually allowed these people to put food on the table and hone their crafts at the same time.
Boredom breeds creativity: there is no difference between inspiration and lack of distraction. They are the same thing.
Creativity isn’t an invention, it’s a reinvention: You don’t develop your own style or voice ex nihilo. You develop it by first understanding somebody else’s style and voice, and then differentiating yourself from it to create your own.
Buy low, Sell High: Understand your market. Learn to spot undervalued ideas and assets. Develop the skill to repurpose them into something people enjoy and value.
Net net, creativity is less about inspiration and more about perspiration 😥.
Section 4: Trivia
Did you know:
Quotable Quote
Writer and entrepreneur Kevin Kelly on making life count:
"I am now 55 years old. Like a lot of people in middle age my late-night thoughts bend to contemplations about how short my remaining time is. Even with increasing longevity there is not enough time to do all that I want. Nowhere close. My friend Stewart Brand, who is now 69, has been arranging his life in blocks of 5 years. Five years is what he says any project worth doing will take. From moment of inception to the last good-riddance, a book, a campaign, a new job, a start-up will take 5 years to play through. So, he asks himself, how many 5 years do I have left? He can count them on one hand even if he is lucky. So this clarifies his choices. If he has less than 5 big things he can do, what will they be?"
Source: My Life Countdown (h/t: 3,2,1 Thursday)
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That's it for this weekend folks.
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Have a wonderful week ahead!!
- Tejas Gutka
[Dec 05, 2020]