Growth Stock Dreams Are Made of These

Editor’s note: This article first appeared in the 22 June 2018 edition of Take Stock Singapore

When it comes to investing, we all have our own little quirks and preferences.

Broadly speaking, we can identify ourselves as an income, value or growth investor. The patient value investor is content to wait for a catalyst for her undervalued shares to appreciate. On the other hand, the income investor is the happiest when there is a steady drip of dividends hitting his bank account every quarter.

Personally, my go-to strategy is growth. My natural instinct as an investor is to look for a long run-way ahead for the company to, well, run.

Let me tell you why.

We are happy to share that one of our stock recommendations from our Stock Advisor Singapore service has more than doubled. Yep, the stock up over 100%. Even better, it happens to be a well-known company that most will be familiar with. Today, I would like to reveal how we sized up the investment opportunity for Amazon (NASDAQ: AMZN) in late February 2017.

The Secret Life of a Growth Investor

For budding growth investors, there are two useful ways to think about the future growth prospects of a company: magnitude and probability.

Magnitude refers to the size of the market that the company is in. Some companies have larger markets compared to others. For instance, local telco StarHub Ltd  (SGX: CC3) offers mobile services in the Singapore market alone. But the mobile penetration rate in our Lion City is already touching 150%. In other words, there might not be much more room left for StarHub to increase its subscriber count.

Compared to StarHub, Amazon is a behemoth. The online retailer generated US$136 billion in sales in 2016, compared to StarHub’s S$2.4 billion. Conventional wisdom would point out that for its size, Amazon would find it hard to grow in the future.

But when we donned our Foolish hats on, we noted that the sum of all ecommerce sales in the US accounted for less than 10% of the entire US retail market in 2016. If we flip it around, there is over 90% of US retail activity that is still happening in physical stores. The potential growth runway, in our eyes, remained significant for Amazon.

But having a long growth runway does not guarantee that the company will succeed in taking market share. That brings us to the second parameter: probability. As the word suggests, probability is about the odds of the company being able to take its fair share of the growth runway ahead of it.

As part of our original recommendation, we highlighted Amazon’s structural advantage stemming from its ownership of hundreds of warehouses. We also pointed out the popularity of Amazon’s Prime service, in which members pay a subscription fee to receive benefits such as two-day shipping; the company revealed in April this year that it has upwards of 100 million Prime members. These are advantages that are hard to match, in our view.

When we put Amazon’s magnitude and probability together, we felt that the odds were on our side that the online retailer could continue on its growth path for years to come.

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A Foolish Take Away

There are many other possible combinations between the two parameters of magnitude and probability.

For instance, it is possible to have a company with a high probability of growth (meaning to say a company that has a strong track record of growth) but with a low magnitude (a small addressable market size).

The right mix of magnitude and probability is really up to the individual investor to decide.

So, the next time you’re thinking about the growth part of the equation, consider using this simple framework to structure your thoughts around a company’s future growth prospects. It could just be an effective way to separate the best from the rest.

At Stock Advisor Singapore, we went beyond the two factors above and dove deeper into Amazon’s web services business, its financial track record, and valuation. We have also been providing earnings updates on the company so that members know how we are thinking about it as it grows.

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Disclosure: The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Chin Hui Leong owns shares in Amazon.