Finance 4820-803 – Growth Stock InvestingInvestment Process and Stock Example

Brian Demain, CFA

Who is Janus and who am I?

Janus is a $170B asset manager. Approximately $110B is invested in growth or core equities, managed out of our Cherry Creek HQs

I manage the Janus Enterprise Fund, a mid-cap growth fund. Before that, I was an analyst following media, telecom, and internet stocks. I have been with Janus 12 years

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What does it mean to be a growth stock investor?

Perception of growth investors as the party animals of the investment world, who love the party while it is going on but are left with a hangover at the end of it. Few newly minted MBAs want to be growth investors, and everyone idolizes the value heroes

Real distinction is between value and momentum. Growth investors believe

they are buying a good value. Momentum investors believe that a rising stock will continue to rise

Growth investors believe value is created by growth that comes at high returns on capital

Google came public in 2004 at $85, or 60x 2004 earnings of $1.40. “Value” investors laughed at this. However, Google will earn about $34 in 2011; it actually came public at 2.5x earnings just a few years out. Future growth meant that Google was a value stock. Growth and value are not mutually exclusive

Denver is one of the growth investing hubs

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Growth stock investing is about returns as much as growth

What are the returns this business generates?

How sustainable are these returns? (Porter’s 5 Forces)

Will returns rise or decline over time?

How will the rate of growth impact returns?

With time and money, can this business model be replicated?

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Growth stock investing is about returns as much as growth

Coca Cola (16x earnings) versus Carnival Cruise Lines (13x earnings)

Would you borrow money at 10% to invest in a CD yielding 5%?

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Growth stock investing is about returns as much as growth

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Growth stock investing is about returns as much as growth

From 2000 to 2010, Medtronic grew its earnings from $1.00 to $3.40, and yet the stock has gone down. The P/E multiple has gone from 60x to 11x

Return on Invested Capital went from 23% to 11% due to a large number of acquisitions

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How do growth investors find ideas?

Secular themes Technology Healthcare Emerging economies

Industry themes New technology in old industries Unique business models Share shifts

Ideas come from industry knowledge. Talk to companies, suppliers, customers, competitors

Big Ideas. As one colleague puts it, swing at beach balls

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Qualitative Research – Learning the Industry

How does the company make money? Price/volume/mix

What do they sell? Know the product

What does it cost to make it? Fixed versus variable costs

Porter’s Five Forces and Return on Invested Capital Who do they compete with? Consolidated or fragmented industry? Who are their customers? Is there concentration or fragmentation? How much

value do their customers see in the product? Who are their suppliers? Could suppliers raise prices? What are the substitutes? Is there a cheaper alternative? Are there new

technologies that are potentiall disruptive? What are the barriers to entry? Time? Money? Distribution? Regulatory?

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Qualitative Research - Is this a good business?

Predictable and sustainable growth Is this a big market? Is this a growing market? What is the company’s share today?

Competitive advantage Better, faster, or cheaper product? Is the advantage sustainable? In the best of all worlds, the product is better, faster, cheaper, and that lead is

sustainable

High quality business model – margins and ROIC Protect against exogenous shocks Beware the capital pig

Good management Insider ownership Good incentives No excuses

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Grassroots Research

Industry conferences

Web boards

Consume the product

Talk to customers/suppliers/competitors/industry experts

People love talking about what they do for a living!

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Meeting management

Will not (can not) yield great insight into current business trends

Management is responsible for strategy, execution, and capital allocation, and this is important

Yes, you are younger and less familiar with their business than they are. But they work for your clients!

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Public Disclosures

SEC filings

10K

10Q

Proxy

Website presentations and calls

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Quantitative Research – What a Model Should Do

Great is the enemy of good

A model should include income statement, balance sheet, cash flow statement, as well as a DCF. The DCF should consider ROIC

What matters in the model? Think in terms of 2-3 leverage points. Price, units, mix, cost structure, capital structure, etc. Get those right; everything else is details

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Quantitative Research - Absolute vs Relative Valuation

Relative valuation – like winning the NIT

Distortions in bubble periods

No two companies are exactly alike

Great for relative value long/short investing, but not for long term investing

The DCF is a blunt instrument but the best way to measure value that we have

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How to Pitch an Idea to a Portfolio Manager

Key levers to an investment thesis – can you pitch the stock in an elevator ride?

Take 3 lines of content and expand, not the other way around

Swing at beach balls – if it is complicated and nuanced, it may work as a value stock, but not as a growth stock

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A Specific Growth Stock Example – Crown Castle (ticker: CCI)

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Is the wireless tower industry a good business?

Predictable growth Recurring revenue from investment grade credits Built-in 3% price escalators from those tenants As sure as the sun rises in the east, the telecom companies will spend

capital on their network

Sustainable growth iPhones and Blackberries for early-stage wireless internet Wireless broadband over the longer term

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Is the wireless tower industry a good business?

Competitive advantage Not in my backyard prevents competition Customers (wireless carriers) literally brand their business around the

quality of their networks. Network quality requires a presence on lots of towers

High margins and high incremental margins Little opex Easier to hang a second antenna than build a new tower Earnings grow faster than revenue as a result

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How we research this industry

Industry conferences.

Speak with network engineers

Pour over financials

Meet with management

Talk with competitors

Detailed financial model focusing on leverage points

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Valuation

Cash flow, not earnings

Discounted cash flow, not relative valuation

Future growth is important to the valuation. If we never saw growth again, the stock would be worth much less than

the current multiple Growth, at high incremental margin and returns, and with long duration,

is worth a tremendous amount This is where growth investing meets value investing; how confident

are we in the growth the business will exhibit?

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Tower economics

A single tower costs about $250K to buildA tenant pays $19K per tower per year, with built-in rent escalators (assume

3% for the sake of this exercise)Today, the average tower has 3.5 tenants. Where could this go? We think to

4.5 over the next 5 yearsA tower costs $20K in fixed costs to operate, and then $1,000 per tenant in

variable costs A tower with ONE tenant generates ($2K) in cash flow on a $250K investment.

This has a negative IRR and negative DCF value TWO tenants = $16K on a $250K investment. 10% IRR and $261K DCF value THREE tens = $34K on a $250K investment. 22% IRR and $532K DCF value FOUR tens = $52K on a $250K investment. 31% IRR and $802K DCF value FIVE tens = $70K on a $250K investment. 38% IRR and $1,073K DCF value

Moving from 3 tenant sto 4 tenants over time is growth, with high incremental return on invested capital. A DCF that doesn’t consider this growth will value this business at $566,000 x the number of towers. But each tenant creates $300,000 in value!

Currently, the stock is valued at $750K/tower. Premium to 3.5 tenants/tower but below fair value

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Growth stock resources

Peter Lynch’s “Beating the Street”

Joel Greenblatt’s “The Little Book that Beats the Market”

Porter’s “Competitive Strategy”

Ralph Wanger’s “A Zebra in Lion Country”

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