Remaining calm without being blind or obstinate

In the current turbulent market environment, some subtle aspects of the Growth Stock Theory of Investing are valuable for investors.

As we have explained in previous posts, one of the key tenets that Rowe Price outlined in his 1973 essay entitled "A Successful Investment Philosophy based on the Growth Stock Theory of Investing" is that most of the big fortunes of the country were made not by timing market cycles but by "retaining ownership of successful business enterprises which continued to grow and prosper over a long period of years."

During periods of stock market capitulation, it often takes a cast-iron stomach to "retain ownership" in a company even when you believe it still has solid growth prospects. But if you want to own those companies for "a long period of years," there will be periods in the interim when the market interrupts with sickening drops that have little or nothing to do with the actual growth prospects of those successful business enterprises.

However, just as it is opposed to the market-cycle approach followed by most "investors," the Growth Stock Theory of Investing is also opposed to a passive "buy and hold" strategy! A shallow view of the previous paragraphs might lead one to conclude that Price was advocating a blind, obstinate resolve to hold a company for decades through hell and high water. But nothing could be further from the truth.

The very term "growth stock" that he selected came from his observation that "corporations have life cycles similar to those of human beings" -- an assertion Price made in a series of articles published in Barron's Financial Weekly in the spring of 1939. He wanted to select companies that were still in the "growth" part of their life cycle.

This observation enabled him to continue to hold a company (if it was still in that growth phase of its life-cycle) regardless of the inevitable market cycles.

BUT it also meant that he was not in the camp of the typical "buy-and-hold" investor, who can sometimes be accurately accused of holding onto a stock that is in the declining phase of its life cycle. Holding onto a company that has stopped innovating may seem conservative, but it can actually be very risky, even foolhardy (as we pointed out in another previous blog post).

Price's 1939 observation (he actually published it in Barron's in 1939, but said that he recognized the truth ten years earlier, so it could in fact be called a 1929 observation) has received a modern re-formulation in a term called the "topple rate" published in a February 2005 McKinsey paper called "Extreme Competition." In that article, authors William I. Huyett and S. Patrick Viguerie examined the rate at which companies in an industry's top quintile (by revenue) fell out of that top quintile. This rate they called the topple rate.

We heard the term in a talk given by Rich Karlgaard in 2005, who later discussed it in a blog article he wrote the same year.

The conclusion of the McKinsey paper (and Rich's 2005 blog post) is that the topple rate has been increasing in recent decades. In other words, the amount of time a company spends at the top of its industry has been dropping rapidly.

The "life cycles" identified by Mr. Price have (in general) been speeding up. While a growth stock investor in 1939 might have been able to own a business that would continue to grow and prosper for many decades, it is now more likely that a growth stock investor can own a business that will continue to grow and prosper for many years, but not for many decades. Rather than obstinately holding companies for some predetermined number of years, someone with a deeper understanding of the Growth Stock Theory of Investing will watch those companies closely for signs that they no longer fit the criteria of a growth company, for signs that they are no longer in the phase of their life cycle that warrants their retention for the future.

However, those signs are found in the company, not in the stampedes of markets like those seen in recent weeks. A true growth stock investor can remain calm during market volatility, without falling into the opposite trap of blind or passive "buy-and-holding."

For later posts dealing with this same topic, see also:
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  1. Do you know how I might be able to obtain a copy of Mr. Prices essay, "A Successful Investment Philosophy based on the Growth Stock Theory of Investing"?

  2. We have a copy that we received from Mr. Taylor, who received it from Mr. Price. However, it is copyright 1973. Based on our reading of US Copyright law, this prevents our making any sort of reproduction of the document or publishing it on the web. According to our understanding of the duration of copyright -- outlined in a US Government circular at this web address -- the soonest that we could make a reproduction of this document will be the year 2068. We regret that we cannot make this document more widely available at this time. However, we will continue to seek avenues of making it available legally, without violating copyright law.

    Thanks for your interest.