The Canadian Investor - Episode 9 - Value vs. Growth Investing and Lululemon

Episode Date: January 27, 2020

This week on The Canadian Investor Podcast we compare value and growth investing and how both approaches differ from each other. We then talk about lululemon and we finish the episode with another Tip of the D’eh! Tickers of stocks mentioned : LULU--- Send in a voice message: https://anchor.fm/the-canadian-investor/messageSee omnystudio.com/listener for privacy information.

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And how am I doing on that French accent, by the way? Oh, it's getting better. That was pretty good. Every show, it's getting better. That was pretty good. Of course, I am Braden Dennis, and today we are going to talk about value versus growth, two highly debated topics in investing strategies. Both have a lot of merit and both make a lot of sense.

People tend to kind of throw themselves in one or the other bucket. Myself, I do both at the same time. I think that's the best way to execute a strategy. And yeah, we can talk a little bit about the differences. So value investing at its core is looking at publicly traded companies and determining if they are a bargain based on what they're worth. And this implements a concept called margin of safety, where Benjamin Graham, who kind of founded value investing with his book, The Intelligent Investor, way, way back, who was a mentor and teacher to Warren Buffett, he introduced this concept called the margin of safety, which basically meant if you could liquidate all of its assets right then and there,

it would be what it's trading for on the stock market. And then you'd be getting a free business. So no matter what, you have that margin of safety built into it, into the price. So you're looking for bargains and trying to find undervalued companies. And that's really the core concept of it. Simon, do you want to talk about growth investing or even add to value investing? Yeah, so definitely value investing. Like Brayden said, you want to look at companies that in your mind or when you do an analysis that they seem undervalued to what they're offering. So there's different ways to look at it.

An easy way to put the margin of safety is just basically projecting what you think the company is worth and then looking at what it's currently worth on the stock market. And then the difference between the two would be your margin of safety. So it gives you, you know, it's never an exact science. It gives you a little bit of leeway in case your analysis is not correct. it gives you a little bit of leeway in case your analysis is not correct. So that's an easy way for people to understand the margin of safety. There's different ways of calculating it, discounted cash flow and things like that. We can probably have a full episode just on that by itself. In terms of for my investing style, so I'm a bit like that too, I'll kind of do a mix of value investing and growth investing. I would say the core of my portfolio is more focused on blue chip companies that I try to get at a good price. And I do keep about 15, 20 percent for companies that are really growth oriented. So in terms of growth companies, what usually people are looking at, well, it's a big basket, so they're not all created equal.

There's a bunch of different metrics that you'll be looking at. You can still look at price-to-earnings ratio that we've talked on previous episodes about. You can still look at price-to-cash flow, price-to-free cash flow. However, when you look at growth investing, there's a big portion of the market that has companies that are actually not profitable so when you start looking at that and they're not profitable where there's no p-ratio if there is no e in terms of earnings or profits so when people are looking at these type of companies they tend to value them differently a little bit. So they'll look at the price to sales, for example. So if any of you are looking at Beyond Meat or Uber, that's a metric that they will be looking at. Or a lot of the marijuana companies are not profitable as well. So they'll

look at the price to sales. So that's a metric that they will be looking at. They're definitely a bit more difficult to value and they tend to look at the future. So there's a lot baked in in terms of expectations of what the company will become. Yeah, that's a great synopsis. Yeah, the typical ratios you'll see on a price to sales or price to earnings, price to free cash flow vary a lot when you're looking at a growth stock.

However, at its core, there is an art to being able to do both by picking up companies that have growing free cash flow, growing revenue, growing earnings, and they're not trading at ridiculous prices. ridiculous prices. And I'll probably talk about Warren Buffett every episode of this show. But he was huge, huge on picking up companies at a bargain price, not really looking at the quality of the business. And it wasn't until he really met Charlie Munger, his business partner at Berkshire Hathaway, that really changed his mindset to finding great quality companies, which will generally have growing top lines, growing profits over the long term at a fair price. And that's where he really shifted his mindset into finding great quality companies. Usually they have growth in them at fair prices. And I personally, I mean, I'm always truly a value investor at heart, but if a company

doesn't have growing free cash flow or growing revenue, at least, I'm just not even going to fish in that pond. And I think it's a lot easier to find winners with high quality businesses that are growing in those areas at fair prices than trying to find a dying business at a deep value discount. That's another strategy called deep value investing, where you're trying to look for turnarounds, companies that the market really, really hates because their business is declining. A company like that comes to my head right now is GameStop. A lot of deep value investors have been trying to pick up GameStop

for five years now, and they have not had a very fun time doing that. So I think GameStop is down about 90% five years to date. So I mean, there's a lot of things you have to consider when you're looking at deep value. Yeah. And one of the things that people, a good analogy, again, if we go back at Warren Buffett, I think he compared those to a cigar butt or a cigarette butt in terms of having a few puffs left in that cigarette or that cigar. So deep value, you want to kind of maximize that little bit of life that's left in the business and recognizing the value. The problem with that is you need to be able to really identify these businesses really well. And as soon as you kind of realize that value and that gain,

and you don't think there's any more value, you really have to sell those because generally what it means is they'll usually go towards zero afterwards. So it gets a little tricky and I would say it's probably something that I personally don't do and I don't think, like you just said, you don't really do yourself. And then in terms of buying great businesses that are increasing profits, increasing sales, increasing cash flow, I've had a great history in the past, and they're going forward, and the prospects look very good. If you can get them at a fair price, you can really, you know, cash in on that over 5, 10, 15, 20 years, or like Warren Buffett would

say, forever, because those are great companies, and you don't have to worry about selling them. You just kind of hold them, you know, until you can't anymore to worry about selling them. You just kind of hold them until you can't anymore for whatever reason. Yeah, exactly. And it comes to companies that are growing at unprecedented rates and extremely profitable, so not trading at insane valuations when you're looking at a PE or something. What comes to mind is the Googlesles of the Microsoft of the world, which, you know, people have been saying are so, so expensive, um, for so long. And if you look at it five years ago and you go, wow, it was so cheap because the earnings have been explosive. And then it keeps that relative valuation, but, you know, earnings have multiplied by five. So it does take that foresight. Good quality companies will always have that, you kick yourself five years later because you thought it was expensive then, but you're like, wow, it was so cheap back then. So that's what makes investing hard, right? You have to be able to look into the future.

Investing is about what you're paying the price now for its returns in the future. So no mean, no one has a crystal ball and that's what makes the whole thing kind of fun. As do-it-yourself investors, we want to keep our fees low. That's why Simone and I have been using Questrade as our online broker for so many years now. Questrade is Canada's number one rated online broker by MoneySense. And with them, Questrade is Canada's number one rated online broker by MoneySense, and with them, you can buy all North American ETFs, not just a few select ones, all commission-free, so that you can choose the ETFs that you want. And they charge no annual RRSP or TFSA account fees. They have an award winning customer service team with real people that are ready to help if you have questions along the way. As a customer myself, I've been impressed with Questrade's customer service.

Whenever I call or email, every support rep is very knowledgeable and they get exactly what I need done quickly. Switch for free today and keep more of your money. Visit Questrade.com for details. That is Questrade.com. Here on the show, we talk about companies with strong two-sided networks make for the best products. I'm going to spend this coming February and March in an Airbnb in South Florida for a combination of work and vacation and realized, hey, my place could be a great Airbnb while I'm away.

Since it's just going to be sitting empty, it could make some extra income. But there are still so many people who don't even think about hosting on Airbnb or think it's a lot of work to get started. But now it is easier than ever with Airbnb's new co-host network. You can hire a local quality co-host to take care of your home and guests. It's a win-win since you make some extra money hosting on Airbnb, but can still focus on enjoying your time away. Find a co-host at airbnb.ca forward slash host. That is airbnb.ca forward slash host. That is Airbnb.ca forward slash host. And one more note I think I'd want to add to growth investing is growth investing can be very tricky because you're looking, there's oftentimes no dividends involved. So there's nothing to fall

back on and kind of create a floor for the price for the price of the company that's one of the things and these companies because the expectations are so high if the company doesn't meet expectations in terms of sales or they fall short of expectations you it's not unusual to see those growth companies being down 30, 50% in a single day because the earnings come out and they just didn't meet the expectations. And one company that comes to mind, it is a U.S. stock and U.S. company, it's called Grubhub. So if you guys look that up, you'll see Grubhub is like DoorDash over here, or it's like Uber Eats and things like that. So they provide food delivery service. And there was a lot of expected growth. And when they came out with the earnings, and they actually didn't meet expectation, the company got completely slashed in terms of price.

So that's something that will happen a lot more with growth companies, because there's such a high expectation for them to, you know, keep growing at an accelerated rate in a lot of cases. Whereas if you buy a really good business at a fair price, you'll actually find that usually those are not as volatile. And in the long term, they'll do as well, if not better, than even the best growth companies. Yeah, exactly. And I look for opportunities where you can find both and even get that dividend as well, like you were talking about. An example that comes to mind is two years ago, I couldn't believe how cheap a big blue chipper alimentation Couchetard was. And if you're not familiar with them, they're the old Max convenience stores. I think they're

still Max branded in Quebec, but Circle K is their big flagship convenience store brand. They grew like a weed down in the States and in Asia as well, and then rebranded it all to Circle K. And for whatever reason, the dividend growth was insane. The revenue growth was insane. On all fundamentals, you're thinking, careful of value traps, making sure you're understanding what their debt structure looks like as well, because there are a lot of really smart people out there and the market might be pricing it low for a reason. So if you do all your checks and you think you really sold on, there's nothing wrong with it, then that's when you jump on an opportunity. And well, since buying it like ATD.B, I'm up close to 100%, I'd say.

I think it's like 80% to date. So that was only two years ago. So sometimes you can find some awesome opportunities where value and growth kind of meet in this awesome intersection. And that's where I spend most of my time. Yeah, and for those who are interested in like getting more into the growth,

having a portion of their portfolio really targeted towards just growth, whether the companies are profitable or not. I mean, I always remember hearing a piece of advice, and I thought it was great, is are you having trouble sleeping at night because of what you own in terms of companies and stocks? And that's a good test. Some people might have higher risk tolerance. They might want to also place bets on companies that are losing money like Amazon was in the late 1990s or early 2000s. going to do that, my best piece of advice is keep it to a small portion of your portfolio, kind of your fun money, if you'd like, a bit like, I mean, it's hard to say, but it's almost like gambling, and you keep that a small portion, and you might hit, you might miss, there might be some of those bets that go bankrupt. If you really want to be doing that with a portion of your

portfolio, keep it a small portion and just be ready. It's very possible that some of these companies will go to zero at some point. Some may have explosive growth, but if you don't overexpose yourself, usually you won't harm yourself too badly. Yeah, that's a really good point. So Simon, I got a question for you. And let's use Topline as an example. When you see a company and you're looking at its five-year fundamentals or even like a year over year, and you see its revenue growth, what number are you looking at and thinking, okay, this is a fast-growing company compared to what a Peter Lynch will call like a stalwart, which is it's increasing, but it's not going to be a 10-bagger. But it's probably a safe thing to own in your portfolio. It's growing, but it's not growing at a really fast rate.

What's kind of that threshold when you see revenue growth or even earnings growth, respectively? threshold when you see revenue growth or even earnings growth, respectively? To really have a really fast-growing company, I would say that's more of a personal thing, and you might hear different things elsewhere. Personally, anything that's in terms of revenue that's increasing by more than 20% a year is pretty fast growth. You'll see some tech businesses that were newly listed or IPOs that are growing at 30, 40, 50% year over year. So that's extremely fast. The only thing you have to keep in mind, it's really hard to repeat those rates year after year.

And what people tend to do, unfortunately, is they'll say, okay, this company grew 30% last year. Well, if it keeps growing at 30%, you know, for the next 10 years, like I'll make about like 500% or whatever on my returns. Well, the bigger the company's growing, the harder it will be to keep that growth rate as high. So you have to keep that in mind. But I would say in terms of stalwart, I guess it varies. I would say anywhere around 5% or more. I think it's very solid in terms of growth year over year. Yeah, exactly. And you'll see that aging.

It's funny. You'll see in the real explosive growth period, you'll see their top line growing, yeah, like you said, 20, 25, all the way up to 50% a year. And then as the company matures, you'll see that revenue start to taper down. But profits will be the one that all of a sudden, their earnings all of a sudden are going into that double-digit 15%, 20% growth. And that's the company signaling that they're really making their business efficient and finding efficiencies and gaining pricing power. So I find watching the evolution in the life cycle of the companies pretty interesting and how those numbers play out. Because I think being a historian of the market is really important, not only to learn from the past, but to also learn

from the types of trends you see with companies maturing out of that growth period, starting to pay a dividend, starting to grow that dividend, and trying to then replicate, you know, where can I position myself to find that next company? Yeah, yeah, definitely. So do you want to talk a little bit about our discussion company? This week we're going to talk about Lululemon. I'll let you take the floor. Yeah, so I think everyone is probably familiar with Lululemon at this point. So just to get an overview of the company, obviously they make their apparel. What I really like about the company

is they have pricing power. I'm sure, you know, everyone knows a woman in their life, whether it's their girlfriend, their spouse. Hey man, I love Lululemon. Well, even guys, and that's what I was going to get at. And I love their stuff too uh but really like if you talk i know i have my fiancee she probably has 15 different pairs and she won't like she will not mind paying a hundred dollars plus for a pair of leggings like at all they have a like

tremendous pricing power and why they're still growing so quickly even though it seems like every woman in canada owns a pair of lululemon it's because they are trying to focus even a bit more on growth in terms of men's apparel and i think i'm like you i do love their clothes all my workout gear is actually lululemon i find that super comfortable super breathable but they do have that pricing power i find they have really good quality and their margins have been improving even as weird as it may sound they were able to grow even though nike under armor and other companies have kind of gone into that space um they've really kept their brand intact they have not discounted much of their stuff they do have some sales but it's

usually not huge discounts and what i really like is they actually do most of their sale direct from directly to customers so whether they have their own shops or they do it online you won't find any lululemon or very rarely any lululemon stuff on Amazon and things like that. You actually go directly to them, which improves their margin. So there is a lot to like about that business. But of course, right now, I feel like it's a little overvalued, but that's a company that I definitely have on my radar. I think it's a company if I can get at the right price, I would own that for years and years. As do-it-yourself investors, we want to keep our fees low. That's why Simone and I have been using Questrade as our online broker for so many years now. Questrade is Canada's number one rated online

broker by MoneySense. And with them, you can buy all North American ETFs, not just a few select ones, all commission-free so that you can choose the ETFs that you want. And they charge no annual RRSP or TFSA account fees. They have an award-winning customer service team with real people that are ready to help if you have questions along the way. As a customer myself, I've been impressed with Questrade's customer service. Whenever I call or email, every support rep is very knowledgeable and they get exactly what I need done quickly. Switch for free today and keep more of your money. Visit Questrade.com for details. That is Questrade.com.

Here on the show, we talk about companies with strong two-sided networks make for the best products. I'm going to spend this coming February and March in an Airbnb in South Florida for a combination of work and vacation and realized, hey, my place could be a great Airbnb while I'm away. Since it's just going to be sitting empty, it could make some extra income. But there are still so many people who don't even think about hosting on Airbnb or think it's a lot of work to get started. But now it is easier than ever with Airbnb's new co-host network. You can hire a local quality co-host to take care of your home and guests. It's a win-win since you make some extra money hosting on Airbnb, but can still focus on enjoying your time away. Find a co-host at airbnb.ca forward slash host.

Yeah, I agree with you on that. I think their stock is priced similar to the kind of multiples that their clothing is priced at. At over 50 times earnings, it's 54 times earnings trailing 12 months right now. Over 8 times sales trailing 12 months and 94 times free cash flow, which these numbers are quite insane. It's at $28 billion in market cap right now, which is quite astounding for a Vancouver startup. And yeah, just looking at the numbers, a 38% return on equity over the last 12 months, 30% return on invested capital. Those numbers are obscene. They're incredibly impressive. However, that valuation, I'm really trying to understand how that's even possible. That's my stance on it right now.

I was saying right before we started recording this with Simon that back when their CEO was getting let go, who was actually their founder, over some controversial statements that he had made, that stock looked incredibly cheap back then. I didn't buy it. I mean, that's stupid for me not to do that. But here we are. Do you happen to know why? And this is a good question. And if you don't know that's fine they used to be listed in canada and they pulled their listing to just be in the u.s on the nasdaq is there like a reason for that is there is there fees obviously they have to pay fees to be publicly listed but that couldn't have been the reason for them to move off of a canadian um exchange

i'm i'm just i'm questioning myself um it's too bad they used to be listed on the tsx i think they pulled it maybe a year and a half ago and i might be wrong on that number yeah i'm uh as you're talking i was kind of trying to google it to see if there was anything. I mean, my best guess would be that, yeah, for fees, it was probably more cost effective. Kind of sucks for Canadian investors that would like to invest on the Toronto Stock Exchange for this company. That would be my best guess in terms of, yeah, I think the article i'm seeing quickly is the volume was too low for them to make it worthwhile to stay on the canadian exchange so they just decided to stay on the nasdaq hmm yeah that's yeah that sounds weird to me like there's something going on that we don't know because their volume couldn't have been that low like they've always been you know a 10 billion plus market cap

for you know at least several years now so and there's a lot of canadian companies that are traded on both the u.s and the toronto stock exchange too so i mean that's what the uh like this article is saying i don't know the real reasons but uh in terms of lululemon for me it's the type of company that I would consider at probably a higher higher price than I would usually for like a lot of other companies the reason I think I mentioned earlier they have like a really good mode pricing power they have margins that are improving they seem to be managing the company very well. And management seems to, even when they change CEOs or C-suite, it seems to kind of just keep going. There seems to be a good culture there, too. Personally, that's the type of company that I would seriously consider buying if it could kind of get close to 30 times price to earnings.

And obviously, compared to what it's trading at right now I would have to go down about half in price but it's a company I'd be willing to pay definitely a bit more of a premium compared to like maybe more traditional value investing yeah that makes sense the the it definitely deserves a premium but it leads me back to all the brands that have had such dominance over decades that you don't even hear of anymore. As soon as Adidas took over Reebok, they stopped putting the effort into the brand and it was more about Adidas. And Reebok has basically, their Lou Lemon has completely capitalized on the trend of athleisure, which is being able to wear jogging pants anywhere you want. So they've really capitalized on that. And you just wonder, when is that we look back and go, that was such a weird trend?

ago that was such a weird trend um so i find trend brands or like clothing brands in general very hard to say that this is going to be a very solid brand in 10 years like i don't know yeah oh yeah right yeah definitely and one the other thing i was kind of looking at too is uh they have a very nice looking balance sheet i. Looking at that and very low debt, I mean, they have more cash than they have total liabilities. Oh, do they, right? Oh, yeah, that's crazy. So they have about the latest, so January 1st, 2019 stats. So it's not super up-to-date, but still pretty close.

They had close to 900 million in total cash and they had less than uh well they had about 650 in total liabilities so that's pretty i mean that's really a nice balance sheet right there um obviously like we said comes at a premium but something i definitely have on my radar if there's a pullback yeah i am seeing here at the end of uh the first quarter 2019 they had almost a billion in cash sitting on their balance sheet um over yeah one and a half billion in current assets yeah that's that's crystal clean that's really nice no debt exactly zero zero on the balance sheet so i mean that's definitely the type of growth companies i do like i like them you know i'm prepared to pay a bit more of a premium

for growth companies i do want them to be profitable and that's a big difference with you know the ubers the i think slack in Slack in the US went out publicly as well. And there's a bunch of them that are not making money. So I do like my growth companies to at least be profitable. And again, at a reasonable valuation, but taking into account that there is a lot of growth involved. Yeah. And it's so speculation based because those companies that were not profitable, like haven't been profitable,

losing billions a quarter like Uber, they had, I know they didn't list until the second half, but using that as an example, those companies had such a strong early 2019 getting pushed to like outrageous valuations. And they've been just horrible to own now for the last six months so it is really speculation based and they kind of move all as and as one um but you're seeing them be horrible to own like canopy growth corp for instance or cannabis you've you've not wanted to own those for six months uh you've lost your shirt on those so i mean yeah it's really speculative so you got to be aware of that kind of risk you're taking on and for those i mean in terms of those looking at these type of companies definitely like make sure you do a lot of research for those and i would even go into uh like

especially for companies that just ipo'd um make sure you give it at least a couple of quarters, listen to the conference calls with management, and at least get a sense if management actually has a plan to get the company profitable, because sometimes they will say there's a path to profitability, and then it just does not make any sense. So yeah, those definitely do your homework if you're gonna even consider those and uh you'll have to put in the time if not i mean you might as well go to the casino and gamble to be honest yeah i'm just looking here at lulu's earnings um it's funny their q4 earnings quadruple their q1 earnings make sense uh with the holiday season so this is a big time of the year for them uh especially with high ticket price like obviously people are buying gifts for each

other and lululemon's has a really strong brand there so i guess it'll be important to see what happens q4 they have uh analysts have their earnings at 21212 a share compared to Q4 of $185 a share in Q4 this year. Yeah, it's pretty good growth. When you look at these multiples, though, you expect more. So I guess that's why we both think it's pretty pricey. Yeah, oh yeah, exactly. All right, anything to add on this one? No, I think we kind of like did a good overview of Lululemon and just kind of to give people a

bit of an idea of what we look at. And it's, you know, it's just a bit of a difference to look at a growth company as well. Absolutely. So to summarize, value and growth investing are among two of the most common investing strategies where you're picking two different types of companies. As mentioned, I like to find where they intersect. I am a value investor at heart, but I find it's a lot easier to fish in a pond of companies that are growing that top line, growing earnings, growing free cash flow, I think you're going to have a lot more success by finding quality first at a good price. Anything to add to that, Simon? Other than that, I think we're good to go. No, no, I think I definitely second that. And I definitely want to be looking for good companies.

Hi, everyone. This is Simon. Thank you for listening to this episode. A quick note on this past episode is that it was pre-recorded in early December. The reason why we can record this week was mainly because I just moved to a new place so it was pretty chaotic. I'm adding this little bit because we did want to add a tip of the day so I'll be adding it without Braden here so our tip of the day today is don't invest money that you need in the short term so in the next couple years general wisdom is you don't want to be investing money in the stock market that you'll need in the next five years the reason for, we did talk about these things in previous episodes,

is that if you do need the money for, say, a down payment for a house in a year or two from now, you find a perfect house and the market happens to be in a bear market or in a correction, it'll be difficult for you to sell that at that point. You might have to sell it at a loss and things like that. So in the short term, you generally want to put that money that you might need, whatever the expenses are, in something that's a bit more secure. You can think about GICs, so Guaranteed Investment Certificates, High Interest Savings Account. There's different ways that you can put that money aside. I'm sure in a future episode, we can talk about what to do when you want to put some cash aside, whether you want to invest that a bit later on or you need that money in the

short term. I think Braden and I have been consistent on this is you want to think about the long term when you invest. So you don't want to be forced to sell in the short term. So I hope you enjoyed this tip of the day and the rest of the episode. The Canadian investor is not to be taken as investment advice. Braden or Simone may own securities mentioned on this podcast. Always make sure to do your own research and due diligence

before making investment decisions. Thanks for listening to this episode of The Canadian Investor. research and due diligence before making investment decisions.