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hello this Chuck carnival co-founder fast graphs the fundamentals analyzer software tool today's video is going to be on one of my favorite investing subjects investing in growth stocks and it's very important to point out that as a value investor commonly known as mr. valuations valuation is just as important investing in growth stocks as any other stock however there is significantly more risk investing in growth stocks which makes evaluation even more the growth stock I'm going to cover today is uLTA Beauty Inc the largest retailer of beauty products in the nation and as I mentioned in the written portion you know Peter Lynch taught me to invest like this you know he often talked about monitoring his shopping habits of his family and then evaluating the stocks after he saw his family purchasing certain things that they really liked and enjoyed and my wife and daughter went shopping recently and came back with a big bag full of uLTA Beauty products so I brought up the fast graphs and what I found was a quintessential example of a growth stock and what I really want to focus on here is what gives a growth stock a higher valuation than a slower growing company that's a primary point that I want to try to convey with this video in order to understand why growth stocks command higher current valuations than slower growing stocks all we have to do is look at the company's earnings growth history so we've got uLTA Beauty here and what I have is a plotting of the company's adjusted operating earnings per share and this is the key to growth stocks in fiscal year 2009 which ends in January I might point out Ulta earned 44 cents a share but look at how the earnings grew to $66 $20 90 last year they earned $6 and 52 cents remember their fiscal year ends in January 31st the point being is that their earnings by 2016 worth more than 10 times higher than they were in 2009 this is the power of high growth this is the power of compounding and when you bought the stock in 2009 the company was earning 44 cents by 2017 the company's earnings 6.52 cents that's more than 15 times as much earnings in 2017 as you originally bought in 2009 and that is where the growth comes from so the reason you can pay a higher premium for a growth stock is because they're generating such a higher magnitude or level of future earnings than a traditional stock let's look at Johnson & Johnson which also deals in certain cosmetics obviously they have a lot of other businesses but this is the triple-a rated one of the premier dividend stocks in the world and what I want you to see here is a real difference so I can do the comparison fair that I'm going to take dividends off and what I want you to see here is that Johnson & Johnson also has a very consistent record of earnings growth it's the magnitude it's the slope of this line that really differentiates the Johnson & Johnson from a aunt of beauty for example and you can see it here just by looking at growth Johnson & Johnson actually had ten times as much earnings as uLTA Beauty did in 2008 and nine however by 2016 17 those earnings had not yet even doubled we're uLTA Beauty has gone up 15 fold that is what separates a growth stock from a pure dividend paying blue-chip stock and it's the growth of earnings it's this development of the future earnings that really gives the company its value so in order to measure that let's do something very interesting here let's look at ulta beauty now but let's add monthly closing stock prices because there's some very interesting aspects of a growth stock like this if I put monthly closing stock prices on the graph here you can see that uLTA Beauty has grown at a very rapid rate but more importantly you can see that the stock rise track that this orange line is a p/e ratio of 31 and that would be a pay grade show of 1 or p/e ratio equal to the 31 point one percent growth rate and you can see clearly how the stock price went where the earnings went and when it got overvalued it came back into value when they became undervalued like it did in 2014 it moves back to value and then above and then back to value now recently the stock has had poor performance in 2017 had a peak price of 315 dollars actually was the high into at 17 and it currently trades around 226 but keep in mind the company has no debt it has a pristine balance sheet and it has an excellent growth rate what I think is also interesting about this particular stock is when I look at gap earnings these are operating earnings when I look at gap earnings I also see that the company has a very consistent record of growing gap earnings at a very high rate so there's not a lot of accounting shenanigans going on with this company although the company doesn't pay dividend the ability to generate cashflow is also very important as you can see uLTA Beauty produces a very high level over 18 percent growth in operating cash flows and free cash flow against Elan dividend paying stock but free cash flow is also important and the company has grown free cash flow very nice and I want you to notice an acceleration and growth expected here more recently now let me talk a little bit about valuation and valuating growth stocks I put monthly closing stock prices back on the graph and I'm looking at adjusted operating earnings again I want you to notice that on September 30th 2008 uLTA Beauty was commanding a PE of 29.3 their growth rate was thirty-one point one percent so the p/e of the orange line is a p/e of 31 so it was trading just slightly below its peg ratio was slightly less than one at this point in time but what I want you to notice is the company grew earnings at over 30 percent a year and had you held it through yesterday's close your total rate of return would have been 35 percent you returned $10,000 into a hundred and seventy thousand dollars that's a 17 fold increase in your money because the company generated a fifteen to seventeen fold growth in its earnings per share but here's the point this is all about growth that's all you have there are no dividends you can see there's no dividends listed on the stock it's purely growth so all of your return comes from capital appreciation and I do want to add here that the recent weakness in Alta beauty in my opinion stems from the fact that the company had become so dramatically overvalued in 2016 in 2017 so this to me was a overshooting of the reversion to the mean and I think the company's back on its way to moving back into alignment with its intrinsic value based on its earth however here's where the alter beauty growth story gets a little tricky going forward there are 25 analysts expecting a good year this year of over 28 percent growth remember their quarter ends today actually January 31st so it'll be about 45 days for me see the quarter but then they're estimating 17 and 25% but notice the number of analysts drop off so we've got a growth rate averaging twenty one point two percent going forward which would indicate a mid double-digit you know nine and a half percent rate of return if you bought the stock here and these earnings actually manifested if you looked at the normal PE and this I love this graph because you can see this company has historically commanded a p/e over 30 now in my opinion and I think this is critically important this p/e ratio valuation now if the company did grow earnings as expected and it did trade at this 36.6 p/e ratio you could see the rates of return could be in excess of 40 percent annualized over the next two years however here's a problem with that when you actually look at the long-term estimates even the analysts are looking at 21 percent there's seven analysts forecasting a three to five year growth rate when you look at the shorter term frame there's a few more analysts forecasting 21% growth going forward so even if we assume that these estimates have been correct and by the way looking at the analyst scorecard over the last five years the analysts have been very accurate forecasting this company so you know that least gives me some comfort that there may be some credibility in these four camps but you still have a double-digit rate of return and this is why I say uLTA Beauty is currently moderately overvalued the reason for it is is because the company's future growth is expected to be significantly slower than its long-term growth so let's analyze historical growth for a minute going to the historical growth tab here and bringing up this tab this shows me the historical growth rates of the company since it's been a public company now I've been focusing mostly on this nine-year growth rate because when companies first go public they come out with a financial statement but they usually show negative earnings growth the first year so I'm looking at as the company's been functioning as a public company and you can see the growth rates have been in the 30 and 40 percent rate but they've slowed down although this year they're expected to be over 30% so you know when you're looking at the company's future earnings growth the company is expected to continue to grow very fast and that would make it an attractive investment however at the same time I don't consider this company to be cheap because if I pick a slower growth rate if I pick a growth rate like 24 percent that changes the dynamic a little bit nevertheless I think the point is I do believe the company is going to continue to grow and part of the reason for that is when I looked a little deeper when I go into fun graphs the fundamental underlying numbers and look at certain things like there's been a lot of discussion about their profit margins shrinking this is a long-term look at the company's gross and rantin and royal blue their net profit margins the company generates 30% plus gross profit margins and brings about 6 to 8 percent of that down to the bottom line as you can see now if I draw this as a line graph I think you get a little better perspective the company's margins have actually improved their net margins have actually improved relative to what they were back in o 6 + o 7 and no 8 and of course they went public right in here so they've got good stable net margins and if I look at the last quarters there's a couple of other interesting aspects of this that I think are worth looking at if I look at the last 12 quarters you can see that their margins have shrunk a little bit through October of last year but they're still in the 7.8 percent range so I don't see any tremendous weakening in the companies you know gross or net margins currently it's a very stable business the company and I pointed out in some of the written portion the company has had a you know very consistent operating history they're fully involved in the online marketing etc so the company is very well positioned it's got a great niche it's an extremely fast growing company with a very strong balance sheet generates good cash flows and is very undervalued relative to historical growth but as we shortened a timeframe I do want you to notice the growth rate has been slowing down so evaluation you know doesn't look as good but keep in mind you can overpay slightly for a company that's building earnings as quickly as Alta beauty's been building earnings no as promised I want to close this video by talking about risk a little bit if we go back to September 2008 we can see that Alta was trading at a 29 p/e that's slightly less than its currently trading at now it's currently trading at a blended p/e of 27 but the company grew by 31 percent a year so when you look at the track record again I mentioned this earlier it gave you a 17 fold increase in your rate of return and that's the excitement of growth stocks they can generate returns that are so much higher than I'm going to use a slightly different timeframe here but here's the performance of alter beauty from January 31st not September 2008 and you can see your money went up about 15 fold and you compare that to the S&P that would have turned 10,000 into 22,000 turning 10,000 and 148 thousand is obviously dramatically different in order to illustrate the risk of investing in growth stocks I want to take a look at a company at the company Stara cycle Inc this company also has a pristine historical growth rate as you can see here up through 2014 I want to emphasize that it looks just like uLTA Beauty did then when you put price on the graph you can see that the price tracked the earnings growth and it did command a premium p/e ratio during this time but the point is this stock also generated very significant rates of return for its shareholders over this timeframe a $10,000 investment December 31st 1998 would have turned in that ten thousand into over three hundred nineteen almost three hundred and twenty thousand that's a twenty four percent compound annual rate of return over this time frame ergo the exciting thing about owning growth stocks but I want you to see very similar to what we saw with Ulta the company are in 20 cents in 1999 it earned four dollars and 27 cents by 2014 that is incredible growth and the growth is what created the economic value but watch what happens where can potentially happen to a growth stock when earnings growth slows down they come into 2015 and earnings growth slows down to only 3% and you can see the stock price started to show some stress I take that out one more year into 2016 and we see another 3% year and now we see a very strong reaction into the stock price bring it up through 2017 now you see some interesting things here and I want you to notice this very quickly I'm gonna go ahead and go out all the way here so you can see the full graph what is really evident when you look at this graph is this flattening of growth here here we have 18% growth I dropped this to a 6% graph we have 4% growth I drop it to a 5% graph and we only have 2% growth and the initiation of a dividend so clearly what this is really all about is growth stocks are great while the music's play and it's like musical chairs but when that music stops like it did in 2015 in 14 you better have a chair and the chair has got to be you know the valuation and the earnings in alignment and there was no chair here and obviously all the assault happened here in the last year's result you know if I go back to the peak here from July of 2015 the current investors in its Terrace cycle would have lost almost half of their money over this period of time all because earnings growth stalled this has been Chuck Carlos and I hope you enjoyed this video on growth stocks I hope you appreciate the opportunity and investing in growth stocks as well as the rest thanks for watching
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