5 MORE Investing Lessons I learned about growth rates
In a prior post I went over 5 lessons I have learned (the hard way) around growth rates. I would recommend you check that out before continuing with this post. They aren’t always lessons, but nuances to consider. Without further delay, here are 5 more lessons I have around growth rates.
Growth via acquisition in a contracting industry - KUT.v
I mentioned in the prior post that I needed to think whether the company is growing inside the industry. What if the industry is declining? Does that mean you should stay away? Maybe. But I don’t. For too long I would dismiss entire industries that are in decline (or at least everyone on X said they were in decline).
KUT is in a unique position to grow inside the industry which is declining (or at least flat) on the aggregate. They can roll up franchisees and/or expand via M&A. They do have some organic growth layered on as well. They have managed to add in scanning and electronic waste to their existing platform. Though these last two don’t move the needle by themselves, when you look at consolidated results it all helps. I get some comfort with KUT that they are essentially running a similar play over and over. So I think it derisks the bet somewhat.
The same can probably be said about natural resource companies. Many believe that we are nearing an end to their use. I disagree. Even met coal still seems likely to be here for a long time given the global demand for cheap energy.
Growth into a different industry - SXP.to
For a long part of my investing journey I thought if a company was going to move into a related industry, I would just take management at their word. I just trusted that they were doing the right thing with my capital.
The example that comes to mind is the company Supremex. I have no position or formal opinion on the company, just using it as an example. They have a strong market position in the envelope business boasting 85% market share in Canada. Their margins and ROIC are high in the business, although it is in decline (or somewhat stagnating). They have decided to take the cash generated by the envelope business (mainly in Canada) and diversify into the US for envelopes and North America packaging business. That business is more fragmented and has the opportunity to specialize to a specific industry or material or size. They have a stated goal of 50% of the business to come from Packaging by the end of 2025. I am not here to judge whether that’s right or wrong. If I was an investor in this business, I would be asking myself something like this.
Is that a reasonable target? How much capital will that take? Where will said capital come from? And what does the business look like if they achieve that target? (Margins, growth rates, leverage, etc.) And what do I think the market will pay for that business. I have seen SXP written up a few times and I don’t see these questions being asked.
On the other hand, take a look at MCB.to. They are diversifying by utilizing their existing expertise in casing running tools and automating as much as they can. The incremental capital is minimal (some opex costs) and the potential TAM is multiples of the market cap.
Growth via acquisition using shares as currency – many microcaps
So many microcaps will need capital and this isn’t bad in and of itself. Many investors (including a younger version of myself) will avoid companies that need to dilute shareholders. I would prefer a company that doesn’t have to dilute, but it isn’t a dealbreaker. I have learned the hard way that per share numbers have to be trending in the right direction. Or if the per share numbers are flat with dilution included, the business needs to be diversifying and becoming more durable. Every circumstance is different and needs to be approached with open eyes. Some great businesses are caught in a situation when they need capital due to external reasons or from prior missteps by a previous management team.
Short term explosive growth due to an external event – ZM (and other covid winners)
I mentioned in my prior post about RX.v growing very quickly then hitting a slower growth phase. ZM is like that, though it’s tied to external elements and RX.v was internal to the business. ZM is a good example of “then what” investing.
Back in the days of covid lockdowns many “investors” were tripping over themselves to get shares of ZM. We were stuck “working” at home as the virus made its way through the population. ZM experienced an insane amount of demand pull. Their quarterly revenue was up over 5x from before the pandemic. The business continued to grow at above average rates in 2022, although slower than the triple digit growth they experienced during the height of the pandemic. Most investors failed to ask what will happen after the huge run in growth. Investors didn’t ask themselves “then what?” What would the growth rate be in 1-2 years? What would the market pay for it? The share price is down 85% from the peak and the business is actually EBIT positive. The business used to trade at over 100x EV/EBITDA and now trades at a very reasonable 10x EV/EBITDA. Crazy. Investors moved on to the next shiny object.
The past does not equal the future in low/no growth businesses - CPH.to
CPH is an X favorite. Or was. Or maybe it is again by the time this post is out. Or maybe it will be the one that people who passed on it take victory laps because they need to feel validated for some reason. Anyway, that’s not why I’m talking about CPH. If you were to look at the top line for CPH for the period from 2014-2017 and compare it to the top line from 2020-2023 you would conclude that it’s a shrinking business. This is where a younger version of myself would have stopped digging. But under the hood, many things were happening, particularly in 2020/21. Yes the top line was coming down, but so were expenses. The new CEO stepped up and made some hard decisions. It’s only now starting to demonstrate some growth in the financial statements. And the share price is up 8-10x. The company was a mulit-bagger even before there was top line growth.
Closing Thoughts
I hope this post was valuable to you. I have some more lessons on growth rates that I’ll save for another post.
Do you have any examples of how you have changed when it comes to estimating growth rates for a business you own? I would love to hear about it.
Thanks for reading.
Dean
*long KUT.v, MCB.to, CPH.to at time of writing