Beautiful Growth Companies, part III

We have previously published many posts which attempt to convey to readers the Taylor Frigon philosophy of classic growth investment.

In an effort to help readers understand what is meant by a "Taylor Frigon growth company," we have from time to time offered examples of specific companies which we own in the portfolios that we manage.

For example, in previous posts "Beautiful Growth Companies" and "Beautiful Growth Companies, part II" we explained some of the fundamental criteria which we believe are important in the analysis of a company's performance, illustrating them with a company which we would classify as a "Taylor Frigon growth company," medical waste disposal company Stericycle.*

Today, we will examine another company which fits our criteria, in an effort to illustrate some other important insights into the question, "What is a growth company?"

We have often cited the concise definition used by Thomas Rowe Price, from whom our growth stock investment philosophy is descended through the late Richard C. Taylor. Mr. Price emphasized "the simplicity and soundness of the growth stock theory" as an investment philosophy, in which "the most important requirement is dynamic, capable management operating in a fertile field of future growth."

He further elaborated on this definition by saying that a growth stock is "a share in a business enterprise which has demonstrated long-term growth of earnings, reaching a new high level per share at the peak of each succeeding major business cycle and which gives indications of reaching new high earnings at the peaks of future business cycles. Earnings growth per share should be at a faster rate than the rise in the cost of living, to offset the expected erosion in the purchasing power of the dollar." He specified a goal of 10% average annual earnings growth, or 7.2% compounded annually, for a ten-year period.

The importance of the above definition is in its emphasis on owning specially-selected businesses through cycles rather than trying to guess which businesses will be best for one cycle or another, the way many investors (both professional investors and individual investors) try to do. We have written about this concept previously (for example, in this post).

One indicator of a company that may meet the definition of a growth company is growth of earnings even in a cycle that appears to be very unfavorable to its industry. This may be an indication that the company is positioned in front of a rich vein of growth, which it can expand even as competitors are forced to contract. Such growth may indicate that the company is adding some new value to clients, creating a paradigm shift or disruption of some kind in its field, as we have discussed in previous posts such as this one.

While high-tech companies seem to be the most natural examples of companies in front of these paradigm-shifting fields of growth, and while we have written extensively about some important tech-related paradigm shifts, there can be growth companies in any business or industry.

To illustrate, we have selected an example from perhaps the most counter-intuitive industry we could find in the current markets -- the financial sector.

During 2008, as the financial industry cratered, shares of FactSet Data were initially hit hard, as investors applied a kind of "guilt by association" to companies having anything to do with the financial sector.**

FactSet sells detailed financial data services to professional investors, competing with other financial data providers such as Thomson Financial, Reuters, and Bloomberg. A significant percentage of their revenues comes from "buy side" investment firms, which manage money for institutions or run mutual funds and other investment vehicles. Investment bankers who need detailed information and analysis during mergers and acquisitions are also among their client base. It would seem that 2008 would be a terrible environment for FactSet.

On the contrary, FactSet grew their earnings per share by 17% during 2008, and grew their revenues by 21%. In fact, 2008 was the company's twenty-eighth straight year of revenue growth.

To apply the ten-year growth standard specified by Mr. Price above, FactSet has grown their net income at a compound annual growth rate of 25.78% (Mr. Price recommended at least a 7.2% compound rate for ten years). In all of the past ten years they grew net income by more than 10% each year over the prior year's total, and in all but three years of the past ten the net income growth was over 20%. In three of those years growth was over 30% and in one of them it was over 40%.

Even in their most recently-reported quarter, net income was up 17% over the same quarter in the previous year.

The reasons for this continued growth -- which surprised the consensus of Wall Street analysts in the most recent quarter -- are several, but they can be summarized by saying that FactSet is a classic growth company that is executing strongly in pursuit of a fertile field of growth. The company is taking market share from their competitors, due to certain ways in which they add value that are unique to their operation.

For one thing, FactSet has always allowed customers to drop their subscription at any time, rather than forcing them to sign up for one-year, three-year, or even longer subscriptions the way their competitors do. FactSet is also unique in that they enable clients to purchase data from a wide variety of sources, rather than one selected source for each type of data, the way many competitors do.

FactSet is also making strong inroads into foreign subscriptions for their service, from money managers in Europe and Asia. Revenues from outside the US continue to grow faster than revenues within the US (16% and 10% for the most recent quarter, respectively). Even during a global slowdown, money managers in India (for example) need a source of data, where more open government economic policy has created a growing need for professional wealth management, just as the economic growth in the 1980s and 1990s did here in the United States.

FactSet is still a small company, relative to their competitors, which is also something we have discussed previously in regards to a company's ability to grow at a faster rate than the rest of their industry or the overall market.

All these characteristics should be well understood by investors, and should help them to understand what we mean when we say that a company is a classic Taylor Frigon growth company.

* The principals of Taylor Frigon Capital Management own shares of Stericycle (SRCL).

** The principals of Taylor Frigon Capital Management own shares of FactSet Data (FDS).

For later discussions of this same topic, see also: