The markets are in a state of panic. History shows that these are often the best times to buy. I’m going to share my growth portfolio below.
Investing is a constant journey. You learn and lots of things on the road to becoming a good investor. I feel pretty happy with my journey so far.
I started on my road to investing by assembling a high-quality dividend portfolio, primarily with Australian stocks. I then ventured out to looking at early-stage small-cap companies providing dividends. While some of my small-cap dividend companies did exceptionally well, there were also a few misses amongst the bunch.
I’ve been resolved to myself that I wanted more certainty in the companies that I was looking to buy, I quickly realized that very early stage companies for investment wasn’t a long-term strategy that I wanted to pursue. Jeremy Siegel’s excellent book Future For Investors reinforced in my mind that high-quality dividend paying companies that were consistently accumulated and held for long periods of time was the best ways to build long-term wealth and a rising dividend income stream. In fact, Siegel advocates that these businesses are the best source of long-term total returns.
By the same token I also noted that there were other non-dividend paying companies that also had exceptionally good rates of long-term total return. It was this realization that led me to want to hold a small group of non-dividend paying stocks that were growth oriented in nature.
I’ve been looking at what types of non-dividend paying growth stocks that I would want to just buy and hold. I quickly determined for myself that high returns on invested capital was a key factor towards long-term value creation.
The key here is that if stocks are purchased at fair value, then it will be the long-term rate of earnings growth that will determine exactly what the total returns will be over a long period of time. Long-term earnings growth will primarily be a function of the rates of return on invested capital.
In general the higher the rate of return on invested capital then the more effectively the company will leverage its retained earnings to deploy in additional growth projects. A combination of high return on invested capital with growth opportunities is the best combination to ensure the best long term returns.
Overlaid on top of high returns on invested capital, I want businesses that have strong barriers to entry that can preserve these high returns on invested capital for the foreseeable future. I also look for these companies that spit out huge amounts of free cash flow annually which steadily grow over time, and also have modest levels of debt.
The final piece of this growth puzzle is to make sure that you buy the stock at a fair or better than fair price. This typically will be at a price where the stocks PE ratio is consistent with the expected long-term earnings growth, or even better the stock can be purchased at a price to earnings growth ratio which is below one.
Interestingly enough it’s actually these types of companies that the market has put on sale right now which I find myself wanting to load up.
With all that said here is what I’m buying right now.
Celgene has probably been my highest conviction purchase right now. This is a business that provides a variety of cancer drugs The business has returns on invested capital that are over 20%. It’s expected to grow earnings at roughly 20% annually for the next five years and it converts almost 30% of its revenues to free cash flow. Best of all Celgene is priced very favorably compared to it’s expected growth.
I have large existing holdings of both Visa and MasterCard. However both of these businesses are on my watchlist for further purchases in major market downturns. Both companies have a long runway of growth ahead and in my opinion will likely grow earnings-per-share in the vicinity of 15 to 20% annually over the next decade.
Visa and MasterCard have exceptionally high returns on invested capital and best of all they convert approximately 50% of revenue into free cash flow. That makes them both very rare and high-quality businesses. I’ve been selectively nibbling at both Visa and MasterCard. The prices are not yet low enough for me to take a really big swing but they’re at attractive enough levels that should make buys at these prices very favorable long-term purchases.
Priceline has been another long term favorite holding that has been shunted by the market for no apparent reason. A 25%-30% revenue to free cash flow conversion, and strong double digit rates of revenue growth has been dismissed by the market, and Priceline has been severely marked down. This business is a keeper however. Returns on invested capital average 20% plus. This is a business that’s just worth buying and slotting away for the next 10 years.
Core Labs is another business that I have been buying. This software business is a rarity in the oil and gas space. Returns on invested capital top 50% annually and the business typically returns 25 to 30% of revenues in free cash flow. The business is a unique one in that it provides oil and gas companies with a way to more efficiently leverage their existing production facilities. That means it should perform well in an environment of either high or low oil prices. I’ve been topping up this business in recent times. In my view it still remains attractive enough at current prices.
Chinese businesses have been uniformly smashed over the last couple months on fears that the Chinese economy is heading into recession. That’s made the prices of both Ali Baba and Baidu exceptionally valuable. While I’m a little cautious on Chinese businesses given the lack of transparency around the financial and regulatory regimes in China, I think Baidu and Ali Baba represent two opportunities that could be purchased relatively safely. I took the opportunity of recent declines in both companies share prices to add to my existing Baidu holding and initiate a new position in Alibaba.
The final business that I’ve initiated a new position in is Chipotle. Now Chipotle has been on my list of businesses to add to for a long period of time. The price was never there. The price finally came into a zone where I was comfortable to initiate a small position. I don’t think it’s terrifically well priced right now and I certainly would be interested in adding to this position at lower levels, however I feel that for an investor that has a long term horizon and is willing to take a little bit of speculative risk Chipotle could well be a position that will reward someone with a 10 year time horizon.
Starbucks is a business that I would really like to add a large holding of to my growth portfolio. The way I’m currently approaching this business is to steadily add to it every quarter through my dividend growth accumulation fund. However should Starbucks drop below $45 a share I will be tempted to take a big swing and add a slug of it to my growth portfolio. Again this is a business that has a good set of growth drivers to increase earnings-per-share for the better part of the next decade and has exceptionally good free cash flow to revenue conversion with high returns on invested capital. It is just not quite at the right price for me to buy a big chunk of it right now