What Quality Growth Really Means

What do they all have in common?

You guessed it. Revenue growth! Consider... NFLX has a 25.5% 20-year compound annual growth rate (CAGR) figure. PCLN, 25.3%. AMZN's is 28.2%. And REGN is most impressive at 54.3%!

Simply put, revenue growth is a key component to massive, life-changing long-term equity returns.

The Quality Growth spell sets its universe of "growth" stocks by limiting the stocks it considers to the average 3-year revenue growth figures that are in the top 20% of the market. As of right now, that throws out any company that hasn't produced a 3-year average figure of at least 23%. Interestingly, this is roughly in line with the long-term revenue growth rates shown above. No slow-moving companies here, these firms are generating a lot of new business year-over-year.

What Makes Growth, Quality Growth?

It is simple enough to just sort the market's stocks by 3-year revenue growth, but there isn't much value added by doing so.

It's the "quality" component that really separates the interesting growth stocks from the rest.

So what makes growth, "quality" growth?

Before answering that, consider how revenue growth is obtained. There are a number of ways. Spending marketing dollars on advertising, hiring a direct sales force, publishing content or research, holding or presenting at industry conferences, and social or viral word-of-mouth are just a sample of these.

In today's business climate, particularly in areas like technology or biotech, rapid revenue growth is seen as critical to securing ever-increasing funding. Venture capital is normally patient with negative earnings and cash flows as long as revenue and other business metrics are rising at a good rate. Additionally, it has become somewhat of a management philosophy (aided by Jeff Bezos at Amazon) to spend rapidly to capture an opportunity quickly and shut out competitors. This method of operation often continues into the public phase of a company's maturation, when it becomes a stock we can buy.

These strategies have merit, but they are risky. Negative earnings and especially cash flows cannot be sustained for long periods of time. Without them, the business must be funded by shareholder-diluting secondary offerings, or by balance sheet-busting debt.

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Disclosure: Steve owns no stocks referenced here.

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