The value of growth
A stock's valuation can be crucial, but portfolio manager James Gautrey highlights why investors should also pay attention to a company's return on invested capital and its reinvestment opportunities.
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It is a mathematical certainty that the higher the price paid, the lower the future return. Yet there are instances when investors should worry less about current valuation – much less, in fact – and those where it will determine almost everything.
Good growth investing should focus on businesses able to earn sustainable, superior returns on invested capital (ROIC) with meaningful opportunities to reinvest at comparable rates. Over time, the compounding effects of such entities will most likely more than compensate the investor for any degradation in near term valuation multiples.
In contrast, companies unable to beat their cost of capital - or even those able to do so but without the ability to reinvest - will never be able to compound.
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