Is Facebook A Screaming Buy Or Sell?

Introduction

This article is directed to the individual investor concerned with achieving the highest possible total return.The highest total return will typically come from a true growth stock simply because a faster growing company is worth more than a slower growing company past, present and future.On the other hand, for that statement to be true, a high rate of earnings growth must be consistently achieved.Generating and sustaining a high rate of earnings growth is the tricky part, because although there are a few companies capable of generating higher earnings growth rates, they are rare.

Additionally, there is one undeniable fact about true growth stocks that is nevertheless hotly debated and argued about. In truth and fact, a pure unadulterated growth stock under the strictest definition is capable of dramatically outperforming most blue-chip dividend paying stocks. The total return differences are not subtle, they are significant and profound. However, I contend it is also an undeniable fact that the risk differential between investing in true growth stocks and blue-chip dividend paying stocks is equally as significant and profound.More simply stated, investing for high growth is risky.

As a result, it logically follows that high-growth stocks are much more research, due diligence and continuous monitoring intensive. Consequently, when investing in growth stocks I suggest you be prepared to put in the necessary work and effort to keep up with the company, its industry and the competition. In a free market, competitors won’t let a high-growth company keep the market to itself.Therefore, if the investor is not willing to put in that effort, then investing in growth stocks may not be appropriate. 

Nevertheless, even though I readily acknowledge that investing in high-growth stocks is undoubtedly riskier than investing in blue-chip dividend growth stocks, their rapid growth can effectively mitigate some of the risk. Thanks to the power of compounding, the company that is growing its earnings very fast can bail investors out even if they overpay for the stock at purchase. Of course, this assumes that the company continues growing earnings at above-average rates. And more importantly, assumes that the investor stays the course, which admittedly is an aggressive assumption.

The Power and Protection Of Higher Earnings Growth

With the above said, this article is primarily about the power, protection and return potential that can occur when investing in growth stocks.  Although I will be referencing Facebook as a quintessential example of a true unadulterated growth stock, I contend that an analysis of Facebook, past, present and future also offers important investing lessons about growth stock investing in general.

Moreover, I consider myself a dedicated value investor.Regular readers of my work will attest to the fact that I consider fair valuation the most important metric to consider before investing in any stock.Not only do I write about the importance of valuation in virtually every article I publish, I have even been given the name MisterValuation and also operate a website under that name.

In the same vein, I consider fair valuation a critical metric to consider and evaluate when selecting high growth stocks just as I do any other stock.However, as I previously alluded to, you can be more liberal with valuation when a company’s earnings growth rate is as high as Facebook (FB) has achieved.In other words, as I will later illustrate, you can actually overpay when initially investing in a high-growth stock and still make an above-average long-term total return.You do take on more risk by doing that, but due to the power of compounding, a high rate of earnings growth can still generate a significant and above-average total rate of return.

This is possible because thanks to the power of compounding, investing in growth stocks can in effect compress time. In other words, instead of taking a decade or more to double your earnings in a slower growing blue-chip dividend growth stock, you can double your earnings much quicker in a true growth stock.

To illustrate my point I will turn to the widely recognized Rule of 72. This rule states that you can calculate the number of years it takes to double your earnings (or your money) at a given compound return by dividing it into the number 72. I have often utilized the following illustration to demonstrate the point I am making about the power of compounding and how it compresses time.