I’ll admit it. When someone asks me what type of investor I am, I always say value investor. But is that accurate? What really is the difference between the two?
On one hand, traditional value investors would describe themselves as ones who buy statistically cheap stocks. The companies they buy may be down and out, but there is still a solid business supported by earnings / cash flows that you can nab for cheap. If sentiment improves or results come in better than feared, that’s all gravy.
On the flip side, I think growth investors are often relegated to universe of momentum investors. They are viewed as ones searching quickly growing companies and often ignore what the earnings of the business are.
But is this description correct or warranted? I often think of growth and value investors as one in the same. Value investors are searching for companies that they think can be a low hurdle that investors are ascribing to the business. Growth investors are searching for assets that they think will beat a high hurdle.
In fact, I’ve come to learn over the years that growth can pay for a lot of sins. As Charlie Munger once said,
“Over the long term, it’s hard for a stock to earn a much better return than the business which underlies it earns. If the business earns 6% on capital over 40 years and you hold it for that 40 years, you’re not going to make much different than a 6% return – even if you originally buy it at a huge discount. Conversely, if a business earns 18% on capital over 20 or 30 years, even if you pay an expensive-looking price, you’ll end up with a fine result.”
Facebook’s recent decline in which it lost more than any other company in a single day is an example of this. At the end of the day, yes. Facebook has had some privacy issues among other things, but it is still a solid platform. They also own Instagram (which I spend way too much time on) and Whatsapp. Indeed, even after the disappointing earnings call that led to the drop, analysts still expect sales to grow 25% over 2018’s level and 21% in 2020. EBITDA is expected to grow at a 20% CAGR as well (slower than sales due to the company’s margin comments).
Let’s examine what can happen when you buy an asset that is growing at this level. Note, this is not Facebook’s results, but an example of how growth can pay for “high-multiple” transgressions. Facebook currently has ~60% EBITDA margins, so allow me to use something more along the lines of Google and Apple at high 30s range (which is still incredible, though capex will also be high).
Let’s say you buy a business similar to this for 20x EBITDA (for context, FB trades for 14.3x est. EBITDA for this year).
Again, these are all made-up numbers, but lets assume strong growth rates for the next few years that starts to level off over time. The business maintains high incremental margins (but offset by capex reinvested in the business). I assume little debt needed as these businesses such as Google, Apple, and Facebook don’t actually consume much cash (which is why their cash balances balloon).
As you can see, the end result is still extremely attractive. I cut the multiple to 8x EBITDA which is well below where it started at 20x. The important factor still, as I have written before, is that the business has a competitive moat so that it can reach these targets. If they can, tech companies in particular are attractive since a company like Facebook or Google have tremendous platforms and additional customers or users cost next to nothing for them to serve.
On the flip side, if you’re buying a fashion retailer (something that is subject to fads), or a technology that is good today but could be disrupted tomorrow, then this is less attractive because it could be here and grow well in year 1, but destroyed in year 2 (perhaps a Snapchat IPOing vs. Instagram stories…).