How Stocks Grow
We buy stocks with the intention that they'll grow our money.

In 100 to 1 In The Stock Market, Thomas Phelps outlined 8 ways a stock grows.

  1. They reinvest earnings at constant or rising returns on invested capital.

If you can utilize incremental capital to generate big returns, your best use of it is to put it back into the company.

  1. Utilize leverage where your rate of return is better than your cost of capital.

I'd prefer as little leverage as possible, but under the right capital allocator, it can be magic.

  1. Acquire other companies via stock issuance. Phelps says he likes it when the PE of the acquirer is lower than the acquired.

To me, this means issuing stock when your company is above intrinsic value to acquire a cheaper company. Not my favorite method, but can work.

  1. The company can increase sales without a corresponding increase in invested capital.

Companies showing this trait have:

Pricing power
Increased efficiency
New methods

  1. Discovery of natural resources like oil, precious metals etc.

You know the story:

Find a hole in the ground
Hole has natural resources
Make money while the resource is highly priced
Sell the company to another sucker.

Doesn't interest me at all.

  1. Innovation that meets a new human need. This could be a product/service that
  • Does something cheaper
  • Improves a customers life

  • Saves the customer money

  1. Government contracts.
These provide monopolies or quasi monopolies, allowing a company to reap the benefits while they have little to no competition.

  1. Rising price-earnings ratios.
Pretty self explanatory. If a company goes from a PE of 10 to a PE of 40. with no change in earnings, you 4x your investment.

I personally like #1, 4, 6, 7, and 8 the most. I won't blacklist due to 2 and 3, if the its in the best interest of shareholders. Which of these do you look for in potential investments?
Joshua Simka's avatar
Number 4 ("The company can increase sales without a corresponding increase in invested capital.") speaks to so many things I look for in a company to invest in. These companies have scale and even optionality—stumbling into new markets, new verticals with little additional investment. I think we're on the same page that #5 (natural resources, oil, precious metals) is a nonstarter! I'm curious to read how others will respond to your post.
The Thinking Investor's avatar
@tomato Agreed! Untapped pricing power is an incredible advantage over competition.
Conor Mac's avatar
In short, there are many ways to skin a cat :)
The Thinking Investor's avatar
@investmenttalk Exactly. Find whatever interests you and attack it.

Author

Related