A week ago, I had written on my ValueGrowth strategy and also introduced three dividend stocks that I like. Dividends are a core component of my strategy as they provide a source of stable, passive income for my family. As I am currently self-employed, this layer of dividends helps to add on to the freelance income that I receive.
Let’s now delve into the “growth” aspect of the ValueGrowth strategy. The word itself is tough to define, as different investors may look at growth differently. Some may be comfortable if a company is growing revenue and profits at 20% yearly, while others may be content with a low single-digit growth rate.
No matter the exact definition, what everyone can agree on is that growth itself has to involve the business showing fundamentally improved numbers and performance, and it is with this rough definition in mind that I dig into the conditions I seek for the companies within my portfolio.
The most important factor I look for are catalysts that are able to drive the growth of the business. These can come in myriad forms, and may include: the building of a new plant, strategic entrance into a new, different market segment, shifting of resources into a high-growth division, renovation or revamping of an asset (so that the company can attract more visitors or charge more per ticket) or building up of competencies to bring the company to the next level.
Note that this is not an exhaustive list of catalysts, but are merely examples of the different types of catalysts that I look out for.
A recent example would be Singapore Technologies Engineering Ltd (SGX: S63). The engineering conglomerate had just announced the acquisition of TransCore for US$2.68 billion to further its smart city ambitions.
Prudent and conservative management
Another key aspect of what I look out for is management that is prudent and conservative. This criteria implies that the growth should be slow and steady, rather than explosive and risky.
It’s easy to observe how management acts and reacts to growth by reading through the tone of the annual report, as well as to observe the initiatives and strategies undertaken to grow the business over time.
Avoiding debt-filled binges
In line with my previous point, management should studiously avoid relying too much on debt to fuel growth.
Debt itself is not a bad thing, but debt-fuelled binges have a nasty way of coming back to bite the company when growth flounders. I do track a company’s debt levels as a proportion of overall equity using the debt-equity ratio, and also observe how well the business generates free cash flows. A little debt is definitely necessary for growth and may even make a company’s balance sheet more efficient.
However, I will eschew companies that pile on debt without a second thought and without keeping an eye on whether they will be able to service the loan should something unexpected occur.
Occasional speed bumps
While growth is an integral part of the ValueGrowth strategy, I am well aware that occasional speed bumps and obstacles are par for the course.
It should be clear that investors should not have an expectation for smooth, uninterrupted growth, but should instead steel themselves for a (somewhat) wild and possibly even jarring ride.
As companies embark on their growth strategies, some may go outside their usual circle of expertise. Progress in this manner may involve tweaking the original strategy or adapting as the business moves along, which results in the speed bumps I mentioned.
In any case, companies rarely witness growth moving upwards in a straight line, and the business may encounter volatility in both revenue and profits for a time before the business picks itself back up again.
Get Smart: Tracking and monitoring
With the kind of growth I look for properly defined, the final step is to continue to track and monitor the business as time passes. Remember that an investment thesis with catalysts usually needs a minimum of two to three years to fully pan out. Monitoring the company is important as the best growth intentions may go off on a tangent, and the investor may feel compelled to sell the stock as the divergence has invalidated his investment thesis.
As long as a company is on track for continued growth, and my investment thesis for ValueGrowth remains valid, I will continue to own it. If growth does falter and the investment becomes a pure yield play, then I will shift and adjust my expectations accordingly.
But is a topic for another day.
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Disclosure: Royston Yang does not own any of the companies mentioned.