In their latest episode of the VALUE: After Hours Podcast, Brewster, Taylor, and Carlisle discuss Your Odds Of Picking Long-Term Growth Companies Are No Better Than A Coin Flip. Here’s an excerpt from the episode:
Tobias: Tobias: Let me kick off a little bit of–
Jake: Who’s your Verdaddy.
Tobias: Yeah, Verdaddy.
Yeah, Verdaddy. I thought this was pretty good. There was a paper that came out in 2001. “The level and persistence of growth rates looking at annual growth rates across all US firms from 1951 to 1997. After carefully conducting tests on multiple measures of earnings, the authors concluded that while some firms have grown at high rates historically, they are relatively rare instances. There is no persistence in long-term earnings growth beyond chance.”
Clearly, we live in a new regime. And so, they wanted to retest. The data ended in 1997. These guys have updated from 1997 to over the last 25 years. I guess, that’s to date. “Testing whether those secular changes that we were discussing before have actually manifested. And so, they find out of sample results corroborate the original papers conclusions using the same methodologies chain we found little to no evidence of persistence in earnings growth beyond chance over the long-term.” And then, now, we’ve got to search for the great line.
Jake: What that saying then is that I think they use some coin flipping methodology for the chance. Basically, your odds of finding those super persistent growers is not great.
Tobias: There’s a little evidence for persistence in revenue, but not much more than chance. And so, this is the great line. “When building a DCF model, it seems analysts might as well plug in the same long-term growth assumptions for SaaS software company as when valuing a coal miner.
Bill: No way. No way. That’s idiocy.
Jake: [laughs] Well– [crosstalk]
Tobias: This is earnings growth, not necessarily return on investment.
Bill: Well, part of the problem is, there’s no fucking earnings. They could grow, [crosstalk] probably, low base pretty well. I don’t know.
Tobias: Anyway, you should read that article. I’ll give you the name of that article to give the boys a shoutout. Persistence of growth by Brian Chingono and Greg Obenshain.
Bill: Here’s the problem with that though. I don’t know that anybody– I guess, what I would want to know is, what is the period that statement starts at? Because– [crosstalk]
Tobias: 1951 to 1997. And then out of sample, 1997 to date.
Bill: Yeah, but then I need to know the slices of the lifecycle of a firm. I don’t think anybody thoughtful builds a DCF. That’s just like, “Ah, this is just–” Mauboussin, you got to have some feed rate and growth, I think, to appreciate what the base rates are. But to look at a company that’s growing– [crosstalk]
Jake: Not if you’re going to get to 2021 prices. [laughs] You better not be fading anything.
Bill: A lot of that was interest rates.
Tobias: It turns out after the fact.
Bill: It’s always been an interest rate. It still is. It will be in 20 years.
Tobias: I think it would be [crosstalk] finding the inflection in the S curve there.
Bill: Some may have. I don’t know who’s right and who’s wrong. I’m not going to dunk on people that are down [crosstalk] 4x.
Tobias: I’m not dunking. I’m not dunking.
Bill: I’m not saying that you are. No need to be defensive, dunker.
Jake: [laughs] Motherdunker.
Bill: Yeah. I don’t know.
Tobias: I think that supports every other bit of research that I’ve ever seen. Growth is too hard to predict. Anything that is a quality metric tends to be reasonably hard to predict. A future flow metric is reasonably hard to predict. That’s all.
Jake: Like Zoom, you might as well just plug in a commodity growth rate on.
Bill: Just say, I’m never going to buy it, which is fine. It’s all on the too hard pile. Anything growing is too hard.
Tobias: I think that that’s fair. I do think that at the early stages of rapid growth, it is very, very hard to see what the future economics is going to look like. And I think that you want to wait until it’s stabilized a little bit before you try and make those predictions, because it’s a prediction business about the underlying. That’s I would agree with it.
Bill: Yeah, that’s fine.
Tobias: This is going to dovetail nicely into what JT is going to do.
Bill: Yeah, well, that I get. But to say Zoom or Fastly– Oh, well, Fastly, I don’t know. It’s a CDN. Datadog? Datadog is not going to grow like a commodity company. No fucking way.
Tobias: Well, the commodity companies may have– The cycles do cycle and they might have a good run here.
Bill: Yeah, they may. I would lay pretty decent odds against commodity growth outperforming Datadog’s growth of earnings over the next 10 years. I think that that I would fade hard.
Jake: I think one of the problems is that there’s assessing that competitively advantaged period is very difficult. Not to pick on Datadog, but how long is a Datadog, a Datadog before it becomes a toaster? Because eventually, everything becomes a toaster. And so, the time period it takes from Datadog to toaster will dictate a lot of the outcomes for you as an investor and what you paid for it. So, I think that that game is very difficult, because it requires you to know what the dynamics of the industry look like out into the future. And that seems like a really hard thing to wrap your mind around.
Bill: Yeah, I think buying cheap shit codes is really fucking difficult, because managements incentives are to screw you. So, nothing’s easy in this game.
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