The Difference Between Growth Investing and Value Investing
10 Stocks to Hold Forever – Part Six
Last week, the day after Apple stock (AAPL) cratered thanks to a disappointing earnings report, we sent an email that included the phrase “We Told You So!”
Was that a bit too much attitude? Perhaps.
After all, no one likes a wise guy.
But I wrote that line, and in the interest of taking full responsibility for it, I want to explain more fully what I was trying to communicate.
The first point was that we (mainly me) had been writing for quite some time about Apple’s extreme popularity and the fact that the stock was ripe for a major downtrend when sentiment began to shift.
In all those writings I was trying to educate readers about the fact that Apple’s extreme popularity was actually a huge risk factor, because when the last buyer of a stock has bought, and there are no more potential buyers, it takes only the slightest whiff of bad news to kick off a long downtrend. I saw it happen in IBM decades ago. I saw it happen in Microsoft. And now I’m watching the beginning of the process in Apple.
As time goes by, I believe the lesson will become clearer to people.
The second point of that article was that if you hadn’t heeded my earlier writings, and found yourself holding AAPL on the morning it cratered, then you should consider a full subscription to our flagship advisory, Cabot Market Letter, so you can get more regular advice and education on the tricky business of investing in growth stocks.
Some readers, happily, took the opportunity to sign up.
But others were irate at what they perceived as hypocrisy. Specifically, they were peeved that our value investing letter (Cabot Benjamin Graham Value Letter) had been recommending buying Apple right up until that morning!
That is true, but it’s not the whole truth.
To see the whole truth, you’ve got to remember that the goal in investing is not to be right; the goal is to make money.
Growth investors make money by holding a moderately diversified portfolio of stocks with improving fundamentals and strong charts, and by selling when those charts deteriorate.
Value investors make money by holding a heavily diversified portfolio of stocks that are undervalued at the time of purchase and holding those stocks patiently until they reach their full value (which can happen through either price appreciation or fundamental deterioration or both).
So the full story with Apple is that editor Roy Ward had been bullish on Apple, on a valuation basis, since February 2011, when the stock was trading at 348. He only turned bearish last week when the fundamentals deteriorated. So, subscribers who bought anytime in the year after his first recommendation were able to make a nice profit when Roy recommended selling. In fact, Roy wrote, “AAPL has advanced 47.6% during the past 23.5 months while the Standard & Poor's 500 Index has increased only 14.0%.”
Those who bought in the second year of his bullishness didn’t do so well, however. At the very worst, a person could have lost 36%.
So was Roy wrong? Well, you could conclude that after he was right, he was wrong, but that’s not the point. Remember, the goal is not to be right or wrong, the goal is to make money.
For any true value investor, the AAPL position should have been one part of one of a well-diversified portfolio. Roy recommends several of these portfolios in Cabot Benjamin Graham Value Letter, and in these portfolios, Roy is doing just fine.
Over the past decade, his Classic Value Model has gained 176% while the Dow is up just 57.1%.
Similarly, over the same decade, his Modern Value Model has gained 111.6% while the S&P 500 is up 61.5%.
I think that’s pretty good.
But back on the growth side, savvy investors stopped looking at Apple long ago, mainly because it was so big and so popular!
Today, they’re working to find “the next Apple,” because that’s where the real growth potential lies.
You’ll find one contender below.
In recent weeks, I’ve been writing a series called “Ten Stocks to Hold Forever,” featuring ten stocks, selected by Cabot editors, that you might choose to, well, “hold forever.”
The sixth stock is LinkedIn (LNKD), and it was selected by Mike Cintolo, editor of both Cabot Market Letter and Cabot Top Ten Trader.
Mike added LNKD to the Model Portfolio of Cabot Market Letter in June at 103. Today, it’s trading at 126, so it’s heading in the right direction. Interestingly, Mike has never done a big write-up on the company, but I have.
In fact, I liked the stock’s potential so much that I made it my December Stock of the Month, and on November 27 of last year, I wrote the following.
LinkedIn Corporation (LNKD)
“Long ago, if you were looking for a job, you looked in the newspaper. Then in the late 1990s, Monster.com burst on the scene, using the Internet to connect workers with jobs far more efficiently than any paper-based medium. It was a great stock—for a while. But Monster Worldwide (MWW) is hitting all-time lows today, because LinkedIn is eating Monster’s lunch.
“The reason: while Monster focused mainly on jobs, LinkedIn focuses mainly on the people in a professional network, and on giving them the tools and connections that enable them to do their jobs better. As a result, LinkedIn, which was launched in 2003, is now the largest professional network in the world, with more than 187 million members.
“Like many networks, LinkedIn is free for any professional to join; in fact every addition of a new individual makes the network more valuable, so LinkedIn encourages this. But the real money for the company comes from users who pay for extras. The number one extra is “Talent Solutions,” which accounts for roughly 55% of the company’s revenues and is used by companies large and small. Cabot has used the service several times to hire high-quality professionals, both local and remote. Big companies, including 85 of the Fortune 100 companies and many professional recruiters, buy “seats” that cost $8,000 per year. Number two is “Marketing Solutions.” As on Facebook, these are basically ads targeted to users. And number three is Premium subscriptions, which give users more tools and connections to do their jobs better.
“All three of these revenue generators are growing fast. Revenues from Talent Solutions were up 95% in the third quarter vs. a year ago, revenues from Marketing Solutions were up 60% and revenues from Premium Subscriptions were up 74%. The result was third quarter revenue growth of 81%, which is a very big factor in the stock’s selection as Stock of the Month.
“Other facts: LinkedIn is available in nineteen languages, and 63% of members are located outside U.S. so this is a truly global company. Now, the stock will be viewed as expensive by some investors, with a market capitalization that’s roughly 10 times trailing 12-month revenues. But we never let valuation stop us from investing in great growth stocks. If you do, you’ll miss some great ones!
“And that brings us to one of the biggest reasons for recommending LinkedIn today. As Cabot Market Letter editor Mike Cintolo wrote in June, “among liquid stocks (more than $50 million in daily trading volume), there are only 12 that have enjoyed triple-digit revenue growth during the past two quarters, and only 12 that have earnings growth projections as high as LinkedIn (up 94% this year, up another 79% in 2013—both numbers probably conservative). And LinkedIn is the only stock that combines the two! Yes, the valuation is high, but the stock is truly unique merchandise for institutional investors; if the market strengthens, institutions could swarm here.”
“Finally, we get to the chart. LNKD came public in May of 2011 at 45, and peaked that week at 123. (That’s the opposite of Facebook’s behavior, which is not to say that Facebook is a bad company, but that the company was too famous and too well-regarded when it came public). And in the 18 months since, LNKD has never been able to break cleanly above that 123 level—even while growth metrics have been stratospheric! In recent months, however, the stock has begin to tighten up, which tells us those institutions are slowly accumulating shares, working to acquire their positions before the eventual breakout. We recommend that you do the same.”
Back in the present, LNKD broke out above resistance at 125 this morning and may finally be on its way. If you want, you can buy now and try to hold forever. It could be the next Apple!
Yours in pursuit of wisdom and wealth,
Editor of Cabot Stock of the Month
10 Forever Stocks – 2013:
Forever stock five is riding the wave of the mass conversion of computer usage from individual PCs to a networked system that optimizes information access...
Forever stock seven is a business software company. We see this as an institutional-quality stockwith years of rapid growth ahead of it ...
This forever stocks series was introduced with Thomas Phelps's Stocks to Buy and Hold Forever idea...