Dear Smart Investor,
Here’s a short quiz for you: which business would you prefer to own?
Company A recently reported a 9% year on year revenue growth for its first quarter and is trading at 30 times its trailing free cash flow.
Company B’s revenue grew by 12% year on year for its latest quarter. Shares are changing hands at around 22 times its trailing free cash flow.
The answer can be obvious.
With all things being equal, Company B wins on both counts: its topline is growing a third faster, while its shares are almost a third cheaper.
Yet, businesses are rarely treated equally in the stock market.
Swinging to the extremes
The companies above aren’t fictitious.
Company B is Zoom Video Communications (NASDAQ: ZM), the poster child of the pandemic.
Shares have been hammered over the past 12 months.
Company A refers to Pepsi (NYSE: PEP), the food and beverage giant, whose shares have experienced a resurgence over the past year.
The fortunes of these two companies could not have been more different.
Since the start of 2021, Zoom shares have taken a beating while Pepsi shares have steadily risen by around 13%.
Despite the vast differences in fortune, Zoom’s revenue and profits have risen by 677% and 500-fold, respectively, since 31 January 2020.
That is why keeping your focus on the business is important.
Eyes on the field, not the scoreboard
Warren Buffett once said that games are won by players who focus on the playing field and not by those whose eyes are glued to the scoreboard.
When share prices fall, most investors assume the worst.
Yet, if you have been paying attention to the business (the playing field) instead of the share price (the scoreboard), you will reach a different conclusion.
Another example: Microsoft (NASDAQ: MSFT), which trades at same valuation as Pepsi, grew its revenue by 18% year on year in its latest quarter, twice the growth rate of the soda giant.
What’s more, the Redmond tech giant’s cloud revenue rose by an even faster 32% year on year, and is poised to become its largest revenue contributor.
All signs point to more spending on cloud computing.
Amazon (NASDAQ: AMZN) chief Andy Jassy said that 95% of the world’s IT spend is still happening on-premise rather than in the cloud.
Given the long runway ahead, Amazon and Microsoft will likely see healthy growth in their cloud computing divisions.
The only timeframe that matters
Of course, cynics will have questions — and rightly so.
If there is business growth, then why are share prices falling?
After all, no one likes to see red ink in their portfolio.
The answer to the question lies in your time horizon.
If you measure based on the performance over the past year, you will be disappointed.
However, if you are able to see beyond the dark clouds today …
… and stretch your view to five years and beyond, we reckon that you will be surprised with the returns that great growth stocks can deliver.
Here’s a case in point:
Microsoft’s strong share price appreciation over the past five years is no fluke.
The tech giant’s stock price has grown alongside its strong free cash flow increase over this period.
In short, if you have the patience, you could be handsomely rewarded if you own the right stocks.
Get Smart: Time to be brave
Let’s be frank.
Is it possible that the share prices of growth stocks could continue falling in the short term?
The answer is yes.
But is it also possible that growth stocks can deliver outsized returns over the long term?
The answer, for me, is a resounding YES.
The good news is that the solution to the uncertainties we experience today is not complicated: follow the business.
That’s why, at our US-focused growth service, The Smart All Star Portfolio, we are laser-focused on the latest business developments.
Our aim has always been the same: to find the best growth companies that we will be willing to buy and hold for the long term.
And here’s the icing on the cake, if you own the right stocks, the lower share prices fall, the higher your chances of a good outcome.
How do you decide if a growth stock is worth your money? There is no shortage of stock ideas today, but is a particular stock suitable for you? Find out more in our latest FREE report, How To Find The Best US Growth Stocks For Your Portfolio. Click HERE to download the report for free now!
Disclosure: Chin Hui Leong owns shares of Microsoft, Amazon and Zoom.