Wednesday, July 26, 2006

Growth Investing :: Future Market Leaders Part I

ThinkEquity Partner's Michael T. Moe has a new post up on the ThinkBLOG about some of what is important in growth companies. ThinkEquity Partners is an investment bank specializing in "companies in the growth sectors of the economy". In some respects growth investing is value investing in the future rather than value investing in the present.

While it is not my style, learning from different perspectives, is essential to success in investing and life itself. Therefore I keep the ThinkBLOG on my hotlist. Let's begin with what Michael T. Moe is looking for in investments.
Companies that dominate a niche and help shape its future are leaders. Companies that may be smaller than the gorilla but have better products, better and more sustainable margins, and/or higher and more visible growth can become leaders. Watch out for them.

There is a central idea lurking behind the many examples and concepts that Michael T. Moe writes about. Growth companies are companies with increasing return on equity. Going back to Finance 101, we learned about the Dupont Analysis. Return on Equity can be decomposed into leverage (assets/equity), turnover (sales/assets) and margin (net income/sales). Crossing out the common factors gives us (net income/equity), which is return on equity.

Companies can grow organically only two ways: they can increase the sales generated by their operating assets, or they can increase the profit from each sale. Increased sales can be driven by many things, but they all start with having a product that people want. After that comes salesmanship and operational excellence to sell and deliver the product. Remember this; it is so important that I am going to repeat it. Increased sales can be driven by many things, but they all start with having a product that people want. After that comes salesmanship and operational excellence to sell and deliver the product.

The combination of an irresistible product and good salesmanship is market share growth. Growing market share is one half of the secret to successful growth investing. Part two of this series will discuss the other half.

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