Growth investing

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14. Case study of a growth stock - Sage

This case study is taken from Jim Slater's The Zulu Principle.

We have deliberately used an example from the late eighties and early nineties so that there is no suggestion of this stock being recommended (or not recommended) in the current market. The case study is an example of the way a growth stock can be analysed. It is not the only way a growth stock can be analysed.

Example

Sage is a supplier of accountancy software:

• In December 1989 it was floated at 130p per share.
• Its prospective earnings for 1990 were 18.6p, so that flotation price was on a P/E of 7.

In The Zulu Principle, a year after the flotation when the shares were 203p, Jim Slater described how the stock fitted into his 'system'.

1. Positive Five Year Record

   The EPS figures for Sage prior to flotation were:
   1986	2.6p
   1987	4.3p
   1988	6.7p
   1989	12.6p
   1990	19.2p

   Although 1990 earnings did not increase at the same rate as the previous three years, 50% is still a phenomenal growth rate for a company of Sage's size.

2. Low P/E Ratio in Relation to the Growth Rate

   At 203p, the shares were priced at less than 11 times 1990 net earnings and at less than 9 times estimated 1991 earnings. Although the growth rate looked like slowing to a more sustainable 25% per annum, the shares were still obviously cheap with an historic PEG factor of only 0.44 and an astonishingly low prospective PEG factor of 0.36.

3. Optimistic Chairman's Statement

   In December 1990, the Chairman said:

   'In the first two months of the current year, we have exceeded our internal targets. Despite the hostile business environment, we are confident that 1991 will be another year of continued growth.'

   You could hardly ask for more.

4. Strong Liquidity, Low Borrowings

   Strong cash flow and £5.5m of net cash, amounting to 17% of market capitalisation, easily satisfied this condition.

5. Competitive Advantage

   A successful strategy coupled with a high level of advertising meant that Sage was continuing to increase market share and margins, despite very difficult conditions generally. Sage had about 40% of the market in small business accounting software in the UK and was growing in the US. There were also many opportunities opening up in the Third World and Eastern Europe.

6. Something New

   The financial difficulties being experienced by the company's main rival, Pegasus, were helping growth of market share in the UK.

7. Small Market Capitalisation

   At 203p the market capitalisation was a very attractive £33.1m.

8. High Relative Strength

   The relative performance against the FT Actuaries All-Share Index was very positive.

   The Sage Group December 1989 - December 1990

   
   
   

9. Dividend Yield

   The yield was a very satisfactory 4.6%. 1990 was the first year a dividend was paid as a public company.

10. Reasonable Asset Position

    Negligible tangible assets, although £5.5m in net cash. The company also had valuable intellectual properties.

11. Management Shareholding

    Directors owned 37% of the shares worth more than £12m, giving them the owner's eye.

Clearly the stock fitted Jim Slater's system extremely well.

• Between December 1990 and May 1992, Sage shares rose from 203p to 469p, a gain of 131%, compared with the market average of 25%.

1. What is a growth stock? 2. Comparison with value investing 3. Traditional characteristics of a growth stock 4. Anatomy of a growth stock - Peter Lynch 5. Ten dos and don'ts from Peter Lynch 6. Jim Slater - The Zulu Principle 7. Earnings growth 8. The PEG factor 9. Competitive advantage 10. Do growth stocks have to be small? 11. A short diversion into internet stocks 12. When to sell a growth stock 13. Other factors 14. Case study of a growth stock - Sage 15. Conclusion

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