Growth is Also Value

The only thing that matters in valuing a company is the company’s future ability to pay dividends. That is all. If we buy a company such as Frontline Shipping [[FRO]], we may receive great dividends in the near term. However, the oil shipping industry is likely at the back side of a cyclical peak in prices. So while we would get great dividends now, and the P/E of the company is low, the company’s future dividend-paying ability will likely fall off drastically. On the other hand, with a quickly growing company such as CHC Helicopter [[FLI]], the company can continue to grow and increase its dividend far into the future.

Warren Buffet called companies like this ‘cigar butt’ companies. With a cigar butt, you can get a few smokes before its gone. With these companies, an investor can get a 20-30% gain as the stock returns to fair value, but that is it. These companies are undervalued, but their future prospects are not great.

The other method of value investing is to find companies that may be fairly valued, but have a great business and great future prospects. Since these ‘value growth’ companies are fairly valued at current earnings, we have a margin of safety even if their growth turns out to be much less than we predict. Thus, even if our predictions are wrong, we will not stand to lose much money. If, on the other hand, we simply bought great growth companies without regard for valuation, we would have no such margin for error.

Warren Buffett once said that he’d rather buy a great company at a fair price than a fair company at a great price. A great company can continue to show great improvements for years, as its business expands. In other words, our potential profit is a lot greater with a fairly valued ‘growth’ company than with a cheaply valued ‘value’ company.

Disclosure: I own no shares of FRO or FLI. My disclosure policy grows its earnings at a rate of 5% per year while paying a 15% dividend yield.

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