Investing in quality and growth: a journey

Investing in growth companies is something entirely different from trying to find true value among bombed out cyclicals, disrupted business models and misjudged disappointments.

Which is why my investment rule number one says: never ask your typical value investor for an opinion on a growth stock.

You know the answers already. It's either too expensive, or it won't last, or the world has gone super-duper crazy.

But growth stocks offer a lot more than the next investment fad or mini-market bubble. As one astute fund manager stated recently: find the right one, and you can keep them in your portfolio for the next decade, possibly longer. Along the way, fortunes are being made and lives are changing - literally.

New Zealand-based a2 Milk (ASX:A2M) achieved a secondary listing on the ASX in March 2015 at a price of 56c. Mid-last year the shares peaked near $20 for a return ex-dividends of no less than circa 3470%. What this means is that $10,000 spent on the first day of trading would have appreciated to $347,000 in a little over five years.

What this also means is that investors could have bought those shares in any meaningful pull back and still have made a huge return on investment. One that literally could prove life-changing.

But those earlier mentioned value investors are correct too. It couldn't last and it didn't. a2 Milk shares are today languishing around $5.50 which translates into a depreciation of approximately -72%. In less than one year. That's one big ouch!

And a2 Milk is far from the only one. Shares in artificial intelligence company Appen ((APX)) peaked below $45 in August last year. They are now changing hands at around $13.50, having recently rallied off a bottom not far above $10.

Credit-but-no-credit provider Afterpay ((APT)) still had the wind firmly in the sails in February with the shares surging well above $150. They are now struggling to hold above $90.

Not all tech

Observation number one is that the concept of achieving a prolonged period of strong growth is by no means reserved for technology companies only.

Apart from a2 Milk, which is a marketer of dairy products by anyone's definition, the past decades have shown extended periods of uninterrupted growth can be achieved by a wide variety of sectors and business models; from medical devices to poker machines and online gaming, to online classifieds and paper and packaging products and services, to car accessories, small electrical appliances and cheap pizzas.

And that's simply limiting my selection of successful Growth stories to the ASX where, arguably, the likes of NextDC (ASX:NXT), Pro Medicus (ASX:PME) and Xero (ASX:XRO) are still in a relatively early stage of what could prove to be another decade of strong growth ahead.

But how do we separate the wheat from the chaff -distinguish between truly sustainable Growth companies and temporary pretenders- and, equally important, how can we know when the tide is shifting as has happened in the case of a2 Milk, and Appen, and Kogan (ASX:KGN), and Blackmores (ASX:BKL), and Redbubble (ASX:RBL), and so many others?

It is here that investing in Growth companies reveals itself as being more art than science. Shares in accountancy software provider Xero have sold off twice already in 2021. First they sank from near $160 to $105 and upon releasing FY21 financials in May the share price pulled back from circa $140 to near $111.

I did not sell my shares, having reduced my exposure a little in February, but I did aggressively increase portfolio exposure during the second pullback. I never climbed on board the register of Afterpay, but if I had I most definitely would not have had the same confidence as with Xero.

One problem with emerging success stories is they sometimes capture the imagination of the crowds, and while everyone is getting excited and boasting about their exposure, the public adulation always makes me wary there's too much money flowing in that is too flighty for its own good. Someone shouts Boo! and risks setting off a stampede towards the exit.

Which is why I much more prefer achievers a la ARB Corp (ASX:ARB), or Breville Group (ASX:BRG), or Ansell (ASX:ANN). I hardly ever receive an enquiry about these companies, but have you checked their performances yet?

This is not to deny that Growth stocks in general can be a lot more volatile than the average stock listed on the ASX. Take the aforementioned a2 Milk for example. Whereas the share price had risen by some 3470% over as little as five-plus years, from 2018 onwards there have been a number of serious pullbacks (-20%, -30%, -40%) that would have made many a shareholder uncomfortable on each occasion.

But also: none of these pullbacks marked the end of the uptrend that remained in place until the middle of last year. If we look back at recent history, we'll find this is quite a common feature for Growth stocks, including for ARB Corp, Breville Group and Ansell.

Such pullbacks are not necessarily always related to a company's performance. Sometimes the market simply gets in a mood to sell everything that trades on above average multiples.

See the first two months of calendar 2021, for instance, or the third quarter of 2018, or the second half of 2016.

While these significant draw-downs always attract a lot of attention from media and market commentators, with the usual explanation given that the shares were simply too expensive, it's good to realise that investors suffering heavy losses is not the sole prerogative of Growth companies.

AMP. QBE Insurance. Telstra. Unibail-Rodamco-Westfield. Not to mention your typical cyclicals such as Woodside Petroleum; they have all caused shareholders serious grief and disappointment, often with losses that are far greater and with very slim prospects of getting back to old share price levels anytime soon, if ever again.

My personal lessons

Us humans are not naturally well-equipped to excel in the share market. Whereas your typical value investment style often requires patience, and a lot more than many have available, investing in Growth companies scares people because of the big accidents and the huge draw downs that do occur.

The extra mental barrier comes from the general misconception that Price-Earnings (PE) multiples define whether a given stock is "cheap" (thus: opportunity) or "expensive" (thus: a disaster waiting to happen).

Simply analysing CSL (ASX:CSL) over the past (nearly) three decades would deliver sufficient counter-evidence of this Grand Misunderstanding, but emotions get in the way, or otherwise our personal biases, the lack of understanding, insufficient in-the-market experience, the fear of suffering losses, or the inability to look beyond the here and now.

It's never a pleasant experience to see the price of your shares falling, let alone dropping like a rock. Unless you are confident and ready to pounce with a big bag of money on the sideline, but I find such ideal scenario is rather seldom a reality.

I don't consider myself your typical Growth stocks investor either. Rather, I aim to seek out those businesses that have that something special; something that makes it worthwhile to stay on board when volatility hits the share price. I don't always get it right, and I definitely don't always respond appropriately or on time.

The portfolio I manage sold out of Appen (ASX:APX) above $20, which is more than -50% below last year's peak, but also more than 100% above the recent low. I was lucky I sold out of Treasury Wine Estates (ASX:TWE) before the Chinese import duties hit the share price. I made good money out of Nanosonics (ASX:NAN) which the All-Weather Portfolio currently does not own. I never anticipated that CSL shares would fall as low as $245 during the post-November pullback.

On average, I find confidence in my understanding and my insights about the companies I select, and this includes their potential weaknesses as much as their competitive prowess, their business moat, the structure of the sector and the embedded corporate quality within.

Every day I learn and I read. Newspapers. Broker research. Company statements. Corporate presentations. Strategy reports. General news. Look as much for negatives as you do for positives.

The most important lesson I can pass on is to not treat investing as a game of being perfect. This is as much about learning, including from mistakes, and finding what suits you best. In the end, if something doesn't suit you, it can never grow into a comfortable fit.

To those with diversified, long-term portfolios, or the desire to build such a portfolio, I can wholeheartedly recommend thou should not dismiss the benefits and beauty of being part of some of Australia's high-quality, pre-eminent success stories. Them being out of favour is usually not a long-winded trend, as also once again proven by the fact CSL shares are grinding their way back towards $290.

FNArena offers plenty of analysis and observations on Quality companies and sustainable growers, on top of proprietary tools and analysis for self-managing and self-researching investors. Our service can be trialed at (VIEW LINK)

Never miss an insight

Enjoy this wire? Hit the ‘like’ button to let us know. Stay up to date with my content by hitting the ‘follow’ button below and you’ll be notified every time I post a wire. Not already a Livewire member? Sign up today to get free access to investment ideas and strategies from Australia’s leading investors.