How to Invest in Growth Stocks

 
Why Price Doesn't Matter

Chipotle Mexican Grill (CMG)

How to Invest in Growth Stocks

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Two weeks ago in this space I recommended five restaurant stocks. I hope you bought some. I'm fairly confident most will be higher in the months ahead.

But I know some of you didn't buy any, and that's fine if you have a good reason... perhaps you already have a restaurant stock or two, or perhaps you're fully invested and have no free cash.

But what's not fine is avoiding these stocks for the wrong reasons.

For example, Dan V. from California responded with the following:

                "Chipotle must be overpriced at $400!!!
 
                "No dividend.
 
                "Enormous PE Ratio.
 
                "I love to eat at Chipotle. But won't stick my neck out at $400 a share."

I like a man with strong opinions, in part because it gives me license to respond strongly.

So, let's get the idea of the dividend out of the way first.

Stocks that pay dividends are appropriate for risk-averse investors looking for additional income and moderate growth. But the presence of a dividend is often a signal that a company's fastest-growing days are behind it.

Of the five restaurant companies I recommended, the two that pay dividends are Starbucks (SBUX), which grew revenues 9% last year, and Yum! Brands (YUM), which grew revenues 11% last year. Both are fine, lower-risk investments.

But investors with an appetite for bigger profits should favor companies that don't pay dividends, like Buffalo Wild Wings (BWLD), which grew 28% last year, or Chipotle (CMG), which grew 24%.

In short, dividends are neither good nor bad, but their presence or absence are part of the big picture, and the clearer your picture of your investment opportunities, the wiser your choices will be.

Now let's tackle the more complex issue of price and value.

First, a stock's price alone means nothing.

Historically, companies conditioned investors to buy stocks priced between $20 and $30. If a stock appreciated far beyond that range, the company would "split" the stock, perhaps doubling the number of shares to cut the price in half, so it would once again be more attractive to individual investors.

The split didn't make the company (or the stock) any more or less valuable.

It enriched--to a small degree--the actors behind the scenes who carried out the machinations that effected the split.

And it certainly didn't change the perceptions of institutional investors.

Yet splits were common, and only one contrary man had the audacity NOT to split the stock of his company as its price soared to the stratosphere over the decades.

That man's name is Warren Buffett. The stock of his company, Berkshire Hathaway (BRK-A) now trades for about $123,000 a share. He doesn't care about making his stock more attractive to individual investors. His main concern is growing the value of his company.

And in recent years, other smart leaders have seen the light.

Google (GOOG) has never split; its stock now trades around 650.

Apple (AAPL) hasn't split since 2005. As almost everyone knows, it now trades around 600, and some analysts are predicting it will hit 700.

Priceline (PCLN) actually did a reverse split (one-for-six) in 2003 when its stock was in the basement, selling for four bucks. It hasn't split since, and now the stock is well above 700!

Among other well-known names ...

Intuitive Surgical (ISRG) trades above 500.

Mastercard (MA) trades above 400.

International Business Machines (IBM)
trades above 200.

And Amazon.com (AMZN) trades near 200.

The high price alone doesn't tell you whether any of these companies are overvalued.  

What it does tell me is that the managers of these companies have taken inspiration from Warren Buffett's "no-splits" religion.

And history tells me these stocks achieved these prices because the managers of these companies did an excellent job of growing their companies ... again, shades of Warren Buffett.

So is CMG overpriced at $400, as Dan claims?

Maybe, maybe not.

But it doesn't matter!

No, the truth is growth investors shouldn't worry about value.

Value investors should worry about value, while growth investors should worry about growth ... recognizing that a stock's price/earnings ratio is the result of performance, not the cause of it.

So the important metrics for CMG are that Chipotle grew revenues 24% last year, and 24% in the fourth quarter. It grew earnings 21% last year and 23% in the fourth quarter. And its after-tax profit margin is holding steady in the 9% to 10% range.

Management has a clear plan to maintain this growth pattern by opening more restaurants; that's the beauty of the "cookie-cutter" restaurant business.

And finally, the stock's chart looks great.

So the way to invest in Chipotle, or any growth stock, is not to worry about value but to worry about trends. Ride the trend for as long as it lasts, and when it ends, make your exit ... again without a single thought about value.

Yours in pursuit of wisdom and wealth,

Timothy Lutts
Publisher
Cabot Wealth Advisory

Editor's note - Investing in dividend-paying stocks is a good way to earn an income from your position without selling shares, but only if you choose the best ones. Click here to get our full list of the 10 best dividend-paying stocks to own in 2012, free with your paid subscription, and turn your portfolio into a cash-generating goldmine.

Timothy Lutts can be found on Google Plus.

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