Growth Rate

If you find a business that can get away with raising prices year after year without losing customers ( an addictive product like cigarettes), you’ve got a terrific investment. Philip Morris( Marlboros cigarettes) can increase earnings by lowering costs and especially by raising prices. That’s the growth rate that really counts: earnings.

You couldn’t raise prices the way Philip Morris does in the apparel industry or the fast food industry or else you’d soon be out of business. But Philip Morris gets progressively richer and richer and can’t find enough things to do with the cash that pile up. The company doesn’t have to invest in expensive blast furnaces, and it doesn’t spend a lot to make a little. Moreover, the company’s costs were greatly reduced after the government told cigarette companies they couldn’t advertise on televisions! This one time where there’s so much lose money around that even diworseification hasn’t hurt the shareholders.

One more thing about growth rate: all else being equal, a 20-percent grower selling at 20 times earnings( a p/e of 20) is much better buy than a 10-percent grower selling at 10 times earnings. This may sound like an esoteric pint, but it’s important to understand what happens to the earnings of the faster grower that propels the stock price.

This in a nutshell is the key to the bigbaggers, and why stocks of 20-precent growers produce huge gains in the market, especially over a number of years. It’s no accident that the Wal-Marts and The Limiteds can go up so much in a decade. It’s all based on the arithmetic of compounded earnings.