Finance 4820-800 – Growth Stock InvestingInvestment Process and Stock Example

Brian Demain, CFA

Who is Janus and who am I?

–Janus is a $170B asset manager. Approximately $95B is invested in growth or core equities, managed out of our Cherry Creek HQs

–I manage the Janus Enterprise Fund, a mid-cap growth fund. Before that, I was an analyst following media, telecom, and internet stocks

What does it mean to be a growth stock investor?

–Perception of growth investors as the party animals of the investment world, who love the party while it is going on but are left with a hangover at the end of it.

–Real distinction is between value and momentum. Growth investors believe they are buying a good value. Momentum investors believe that a rising stock will continue to rise

–Growth investors believe value is created by growth that comes at high returns on capital

–Google came public in 2004 at $85, or 60x earnings of $1.40. “Value” investors laughed at this. However, Google will earn about $23 in 2009; it actually came public at 3.7x earnings. Future growth meant that Google was a value stock

–Denver is one of the growth investing hubs

Growth stock investing is about returns as much as growth

• What are the returns this business generates?

• How sustainable are these returns? (Porter’s 5 Forces)

• Will returns rise or decline over time?

• How will the rate of growth impact returns?

• With time and money, can this business model be replicated?

Growth stock investing is about returns as much as growth

• Coca Cola (16x earnings) versus Carnival Cruise Lines (13x earnings)

• Would you borrow money at 10% to invest in a CD yielding 5%?

Growth stock investing is about returns as much as growth

Growth stock investing is about returns as much as growth

• From 2000 to 2009, Medtronic grew its earnings from $1.00 to $2.92, and yet the stock was flat. The P/E multiple has gone from 60x to 15x

• Return on Invested Capital went from 23% to 11% due to a large number of acquisitions

How do growth investors find ideas?

–Secular themes• Technology• Healthcare• Emerging economies

–Industry themes• New technology in old industries• Share shifts

–Ideas come from industry knowledge. Talk to companies, suppliers, customers, competitors

Qualitative Research – Learning the Industry

–How does the company make money?• Price/volume/mix

–What do they sell? • Know the product

–What does it cost to make it?• Fixed versus variable costs

–Porter’s Five Forces and Return on Invested Capital• Who do they compete with? Consolidated or fragmented industry?• Who are their customers? Is there concentration or fragmentation? How much

value do their customers see in the product?• Who are their suppliers? Could suppliers raise prices?• What are the substitutes? Is there a cheaper alternative? Are there new

technologies that are potentially disruptive? • What are the barriers to entry? Time? Money? Distribution? Regulatory?

Qualitative Research - Is this a good business?

–Predictable and sustainable growth

–Competitive advantage

–High quality business model – margins and ROIC

–Good management

Grassroots Research

–Industry conferences

–Web boards

–Consume the product

–Talk to customers/suppliers/competitors/industry experts

Meeting management

–Will not (can not) yield great insight into current business trends

–Management is responsible for strategy, execution, and capital allocation, and this is important

–Yes, you are younger and less knowledgeable about their business than they are. But they work for your clients!

Public Disclosures

–SEC filings

• 10K

• 10Q

• Proxy

–Website presentations and calls

Quantitative Research – What a Model Should Do

–Great is the enemy of good

–A model should include income statement, balance sheet, cash flow statement, as well as a DCF

–What matters in the model? Think in terms of 2-3 leverage points. Price, units, mix, cost structure, capital structure, etc.

Quantitative Research - Absolute vs Relative Valuation

–Relative valuation – like winning the NIT

• Distortions in bubble periods

• No two companies are exactly alike

• Great for relative value long/short investing, but not for long term investing

–The DCF is a blunt instrument but the best way to measure value that we have

How to Pitch an Idea to a Portfolio Manager

–Key levers to an investment thesis – can you pitch the stock in an elevator ride?

–Take 3 lines of content and expand, not the other way around

A Specific Growth Stock Example – Crown Castle (ticker: CCI)

Is the wireless tower industry a good business?

–Predictable growth• Recurring revenue from investment grade credits

–Sustainable growth• iPhones and Blackberries

Is the wireless tower industry a good business?

–Competitive advantage• Not in my backyard

–High margins and high incremental margins• Little opex• Easier to hang a second antenna than build a new tower• Earnings grow faster than revenue as a result

How we research this industry

–Industry conferences

–Speak with network engineers

–Pour over financials

–Meet with management

–Talk with competitors

–Detailed financial model focusing on leverage points

Valuation

–Cash flow, not earnings

–Discounted cash flow, not relative valuation

–Future growth is important to the valuation. • If we never saw growth again, the stock would be worth much less than

the current multiple• Growth, at high incremental margin and returns, and with long duration,

is worth a tremendous amount

Tower economics

–A single tower costs about $250,000 to build–A tenant pays $19,000 per tower per year, with built-in rent escalators (assume

3% for the sake of this exercise)–Today, the average tower has 3 tenants. Where could this go?–A tower costs $20,000 in fixed costs to operate, and then $1,000 per tenant in

variable costs• A tower with ONE tenant generates ($2,000) in cash flow on a $250,000

investment. This has a negative IRR and negative DCF value• A tower with TWO tenants generates $16,000 in cash flow on a $250,000

investment. This has a 6% IRR and $266,000 DCF value• A tower with THREE tenants generates $34,000 in cash flow on a $400,000

investment. This has a 14% IRR and $566,000 DCF value• A tower with FOUR tenants generates $52,000 in cash flow on a $400,000

investment. This has a 14% IRR and $866,000 DCF value–Moving from 1 tenant to 4 tenants over time is growth, with high incremental

return on invested capital. A DCF that doesn’t consider this growth will value this business at $566,000 x the number of towers. But each tenant creates $300,000 in value!

Growth stock resources

–Peter Lynch’s “Beating the Street”

–Joel Greenblatt’s “The Little Book that Beats the Market”

–Porter’s “Competitive Strategy”

–Ralph Wanger’s “A Zebra in Lion Country”