Authored By Louis Stevens
In today's Brief, we will consider Peter Lynch's Fast Growers framework, which he articulated in two distinct instances in his book, "One Up On Wall Street."
I believe this is worth our time because it creates a more conversational structure to this brief, and it sheds light on the nature of the companies that predominantly populate LAS' coverage universe, virtually all of which are growing between 20-50%+, with solid free cash flow and giant cash hoards (often no debt).
I've talked about Peter Lynch's Fast Growers framework in the past; specifically in "Stocks That Grow Fast," so be sure to check that brief out as well. We will also leverage "An Attractive Setup" in today's brief, which itself has a devoted brief, so be sure to check that out. I linked both of these briefs below.
The central purpose for these briefs, as well as the brief you're reading today, is to give you frameworks with which we better understand the businesses we own, why we own them, and how we can find more exceptional businesses like them.
Alright, without further ado, let's start by reviewing the text from One Up On Wall Street in which Mr. Lynch detailed his Fast Growers framework in a series of bullet points. Note that I completed the excerpt from the book by typing it out just below the screenshot.
..."those little white tags to their established customers. So, in 1983, when the rate of growth slowed, earnings didn't just slow, they dived. And so did the stock, from $42 to $6 in twelve months.
- That few institutions own the stock and only a handful of analysts have ever heard of it. With fast growers on the rise this is a big plus. "
The first bullet point is interesting insofar as it relates only to businesses that would fit within "An Attractive Setup" (detailed in the link above).
Examples of companies that would fit within this first bullet point, i.e., companies set to experience rapid growth due to new product lines growing rapidly and boosting earnings, have been Amazon by way of AWS over the last 15 years or Apple by way of its software business over the last 10 years. In both of these examples, the companies had durable, profitable legacy businesses, e.g., Amazon's 1P/3P ecommerce and Apple's hardware ecosystem, that provided underlying stability atop of which the new lines of businesses could grow rapidly and create likewise rapid share price appreciation.
These are, of course, very prominent examples from rather mature companies. Moving down the scale of maturity (towards relative youth), today, Crowdstrike's Cloud Security business, brought into focus recently by Alphabet's proposed acquisition of a pure play cloud security vendor, Wiz, is a rapidly growing business that's been launched atop Crowdstrike's durable, profitable legacy business, i.e., its Endpoint product.
Crowdstrike's Massive, Rapidly Growing Cloud Security Business
Datadog's Illustration Of The Cloud Security TAM
Axon is basically as mature as Amazon or Apple, but it's at a much smaller scale ($21B is still very large). It exemplifies this first bullet point from Mr. Lynch in that its software business has experienced meteoric growth atop Axon's durable, profitable legacy hardware business.
Axon's Software Business Has Grown At A Meteoric Rate, Pushing Upward On The Overall Business' Growth
(I invite you to read yesterday's brief in which I considered the Axon business.)
Tesla's Energy business, or what I've called its AWS, is one to watch here over time, as the line of business is still not large enough to meaningfully impact Tesla's top line sales or profitability. There's a great deal of uncertainty here, and Mr. Lynch noted in the first bullet point that we should consider the degree to which the new line of business will impact total sales over time. Meta's WhatsApp is another interesting example in this vein. In both of these examples, Messrs. Musk and Zuck have made rather bold assertions as to the eventual scale of these lines of business, by which they could transform Tesla and Meta into Fast Growers that are also Attractive Setups; however, as of today, we're not quite there yet.
I invite you to learn more about Tesla's AWS via this link.
That said, because they have durable, profitable legacy lines of business, it's vastly more palatable (as in there's less risk) to bet on these up and coming lines of business, as opposed to betting on pure playmoonshot bets that may or may not work over time.
At the very least, investors cannot scale their investment operations betting on moonshot, single product companies with very little revenue. It just wouldn't be prudent in terms of risk management.
Mr. Lynch also had a comment on moonshot bets that went something to the effect of, "I've made 20 moonshot bets, and 0 have worked out for me. I'm 0/20 on moonshot bets."
Lastly, Palantir's government business has been a great example of a Fast Grower in An Attractive Setup, in that its government business has provided a durable, profitable foundation atop of which it's grown its rapidly growing commercial business.
Palantir's U.S. Commercial Count Growth
All of the aforementioned businesses are examples of Fast Growers in Attractive Setups. These are the best Fast Growers, and, because multi-product platform businesses largely comprise LAS' coverage universe, most of the companies we discuss are Fast Growers in Attractive Setups. Awesome.
But not all Fast Growers are Attractive Setups (remember, Attractive Setups is a framework. I'm not using the phrase literally here.).
Some Fast Growers just have one product, or one mousetrap, that they successfully replicate over and over again within their total addressable market. Hopefully, and it's usually the case, these one-product-fast growers offer something that is unique and its unit economics are likewise unique whereby they benefit from The Innovator's Dilemma. We've discussed this idea often in past Briefs.
Good examples of the 3rd and 4th bullet points are CAVA, Chipotle, and Guzman Y Gomez (GYG). These are simple businesses with profitable unit economics that have found success in more than one place in the world and are now rapidly expanding.
But, with the 5th bullet point in mind, CAVA and CMG are quite pricey relative to their growth. Mr. Lynch would frankly be appalled by the speculation that has been underway in the QSR (quick service restaurant) space in recent years. From CAVA to WingStop to Chipotle, you'd think they told the market they sold chips... Come to think of it, maybe that's what happened. They announced their new tortilla or pita chip offerings, and the market thought they meant AI infrastructure, hence their recent bubble-like rises.
With respect to the 5th bullet point, this is a matter of identifying runway for growth. In the case of Chipotle, it has 3,000 locations in the U.S. Management has stated that they plan to open a total of 7,000 in North America, and Chipotle has also begun expansion into Europe and the Middle East.
CAVA, on the other hand, and GYG still only have a few hundred locations, so theoretically, their runways for growth are much longer. I would say that it's generally better to err on the side of, "This could go on a lot longer than anyone expects," especially when you find yourself in a company like Chipotle, Costco, Nvidia, or Amazon, i.e., a winner that has been winning for decades. We will invariably own losers with this tenacity of ownership, but our winners will dwarf the losers by wide, wide (wide) margins over time.
Lastly, the seventh bullet point is interesting to me insofar as most of the companies I share with you are well covered. In fact, these were the most popular companies of the last 10-15 years in both public and private markets.
But, astonishingly, as they hit their greatest positions of strength with huge cash hoards and solid free cash flow generation, investors fled their shares. In another part of One Up On Wall Street, Mr. Lynch noted that he liked businesses that were formerly popular but had fallen out of favor.
This describes virtually every single popular software and fintech name of the last 10-15 years. It's been as astonishing as Mr. Buffett's characterization of the late 1970s, which he shared with us in his famous Georgia Terry School of Business lecture.
To close, hopefully, these ideas gave you confidence to own the businesses you own and to buy quality businesses in the future, destined to grow their earnings at elevated rates for years and decades to come.
Disclosures:
L.A. Stevens has rated Tesla a "buy."
L.A. Stevens has not rated the other companies, largely due to their inflated valuations today.
