Rule #1 Finance Blog

With Investor Phil Town

NAILING THE GROWTH RATE

Quick post about growth rates and moat. Edited for length.

Question:

Hi Phil Town,

First of all – Great book! The most entertaining and “real” book on investing I’ve read.

In your eval of EBAY, you take a projected EPS value between the analysts and the CEO’s projections. But with DELL, you stick with the CEO’s. Please explain.

Thanks in advance for answering me.

Al F.

Answer:

Nailing the growth rate is not all science.  There is a bit of art.

Warren Buffett suggests that if the growth rate doesn’t jump right out at you, it’s too close to call — but then again, he’s a genius with a lifetime of experience.  Me, I’m a river guide with half a lifetime of experience, and although growth rates don’t just jump out at me most of the time, on the businesses I like, I feel competent enough to call the growth rate.

Here’s the deal with Dell and Ebay:

I think the Dell CEO was being real when he called the 10% growth for
the future.  He sounded kind of frustrated, like “Why anyone would
think that Dell could continue its massive growth at the size it
became?”  So I believed him.

Meg Whitman, on the other hand, seemed like she was just trying to calm
down the buying frenzy and put a note of reality into the mix by saying
that 40% wasn’t going to keep happening… More like 19% or so.  And
then Ebay went off and had a 30% plus growth year!  So I sort of
extrapolate from my experience.


So what should you do? 

First thing is to stick with Buffett 101: If the growth rate doesn’t
just jump out at you, then it may be too close for you to call at this
time.

Maybe dig into the company a bit more to get more comfortable with it.
Do some reading — like the 10Ks back a few years.  The CEO letter to
shareholders.  Listen to some calls.  Go to the stores and see what
people think who work there or shop there.  Kick the tires.  Be a
consumer.  And be a good shopper.  Ask yourself shopping questions:
Can I get this product somewhere else even cheaper?  Is it likely that
someone could compete with these guys down the road?  Make sure you
know the Moat.


Speaking of Moat — the more Moat you have, the less likely you’ll make a mistake on the MOS thing.

Moats are not only protection from competition — they are also the
source of great consistency.  If you don’t have to periodically fight
of competitors by dropping your price or constantly coming out with a
new model, you can plan better and be a more consistent grower.

CEOs who run a tight ship hate to have to hire a lot of people or buy a
lot of machinery to gear up for greater sales, and then fire the
newbies and let the equipment sit idle when the market suddenly cools
off or they lose share to a competitor.  Those kinds of businesses have
shaky Moats, and we try to avoid those.  The consistent growers are
where our confidence is placed for growth rates.

Now go play!

Phil Town