Analyzing Growth Stock (Part 1)

Objective

The objective of this post is to form a framework of how to analyse a growth stocks and understand the risk and reward from peter lynch perspective. This type of analysis will give you a brief overview, if the buisness worth your time to look deeper.

Introduction

Growth stocks are the hot topic today. I going to put into Peter Lynch perspective of growth stocks, the danger, how to evaluate and justisify a good investment returns.

i would first start off by quoting "One Up On Wall Street", Peter Lynch's warnings for dot com stocks to relate to today situation and this will form the basis of methodology of the analysis.

What is he looking at to justify the stock prices today?

• Market capitalisation
• Earnings
• Revenue

• Story

Thumbnail Analysis

Summarise of Growth stock investing thesis:

• 2x in 5 years, thus market cap must x2. Expected returns 15% p.a.
• Divide the market cap in 5 years with PE of 40, you will get the net income

• Estimate profit margin of 10%. Revenue is 10 time of net income

Analysis the top 10 holdings of Arkk ETF

The table below, summarise in order to justify today market capitalisation, how much the company need to grow their revenue. For example, for $SHOP, it need to grow 29x revenue in 5 years. Some are maybe possible like SQ and SPOT, 3x. While some are really crazy. Tesla may 10x because of all the ramp up production, but more probably in 10 years rather than 5 years, in my opinon.

Try to build the story and assessing the Risks

The concept of investing in growth stocks:

• Total addressable market
• Competition when buisness model work
• Investment required for growth
• Growth and profit
• Proof of concept

EXAMPLE: Zoom

You have to ask yourself:

• Today total addressable market is $43 billion by zoom, does it make sense that the market capitalisation is $75 billions?

• When we look at the buisness, we must look at who he competing with does it have any competitive advantage against giant like google? If it is so unique can google just acquire it?

• Buisness can grow by taking on debt or issue shares. ROIC above 14% (avg of S&P) with show how efficient they are. However, you should also ensure current asset more than current debt. Also shares outstanding, which affect the EPS, in long term Earnings line is correlated to stock price. You can grow very easy if you just burn money. Eg. You make a product for $2 and sell it for $1 your revenue will grow fast .

• Zoom is profitable which is good. However, when there is sharp increase of earning we should always question why and is it sustainable.

So the risks of ZOOM is the Market and Growth.

The Growth Strategy Risks & Rewards

If a portfolio consists of all growth stocks. Expect high risks.

Example:

if you buy all the 10 growth stocks, $1000 each.

If 9 go bankrupt, 1 go 10x, you get back your money.

If 1 go 100x, you 10x your money.

if all bankrupt, you get 0.

Therefore, with initial investment of $100k, if you can 4x your money every year or 10x your money every 2 - 3 years. You will be as rich Warren buffet in 10 years time, which he take 91 years. However, i know i am simply not smart enough to do that.

Conclusions

I will quote another paragraph from Peter Lynch's "One up on wall street" to conclude.