How to Analyze Growth Stocks – Simple Delta of the Delta Tool – Visa 15% Growth Stock Example
How to analyze growth stocks
A tool that is extremely important when it comes to growth stocks analysis is the delta of the delta. We will use Visa as a growth stock example and by the end of the article you will have another valuable tool when it comes to assessing the risk and reward of an investment, in this case a growth stock. The following chart explains the growth stock analysis we will discuss and what you’ll fully master by the end of the article.
Growth stocks – The decade of
The last decade has been the decade of growth stocks. The Nasdaq index is up almost 6 times over the last decade.
That is an amazing performance and tech businenesses,
growth stocks, did perform really well over the past decade. However, did those
businesses perform as well as their respective stock prices?
Microsoft’s (MSFT) price to earnings ratio increased
from 7.5 in 2011 to the current 30.
expansions tell us that investors expect strong growth rates going forward that
justify paying a relatively high price for a growth stock. The expectation of
future growth, in combination with current growth, is what keeps the stock
price going higher and higher as investors combine current strong business
growth with even higher expectations of growth in the future. This leads to
growing PE ratios and consequently constantly higher stock prices.
As investors, we
have to look at the key factor that will influence future investment returns:
the delta of the delta – the change in the growth. I have recently analysed Visa stock
and it will serve as a great example for the application of this tool. Let me
give you first a quick introduction to Visa’s stock and then we’ll apply the
technique to make a Visa growth stock analysis.
Growth Stock Analysis
Visa Stock (NYSE:V) is the ultimate compounder. Revenue
keeps growing, earnings and cash flows too, that leads to constantly higher
dividends while the market for Visa simply keeps increasing thanks to global
Visa growth stock – revenue growth
I have two bank accounts; one is Visa the other is
MasterCard. I think if you open your wallet, you’ll probably find a Visa card.
On the other hand, Visa’s
stock also comes with a high valuation and low dividend. The whole game with
Visa stock is that it has to continue to grow and compound for the stock price
to keep growing. As soon as the growth slows down, there will be a big hit for
the stock too.
Fortunately for Visa stock holders, the company just keeps on giving and giving. They have a low dividend payout ratio of around 20% because they can reinvest capital at rates above 20%.
The company has all what you can dream about when it comes to investing; growing revenues, a high margin, high return on invested capital alongside constantly growing distributions to shareholders. Apart from the dividend, the number of Visa stock outstanding fell from 3 billion to 2.2 billion over the last 10 years. That is almost 30% less than the number of Visa stocks outstanding in 2009!
Visa’s growth comes from their strong moat that is also reflected within their extremely high net profit margin of 50%.
The outlook is simple when it comes to Visa stock. For as long as the company can keep growing earnigns at 15% per year, the stock will follow. The menagement expects the company to continue to grow earnings in the mid-teens range.
When it comes to investing, it all depends on growth. If there is an economic halt, Visa’s traffic and profitability could stagnate for a while and consequently the stock would stagnate too. Visa is definitely a business that compounds, but I would say fairly priced given the PE ratio of around 30. If earnings continue to compound at 15% per year, the PE ratio on the current price will be just 15 in 5 years and just 7.5 in 10 years. The stock price will consequently grow alonside earnings growth at a constant valuation.
Visa earnings analysis
So, the questions are:
continue to grow as fast for a long time?
What happens if
Visa’s growth is in the low teens or in the high teens?
The answers to the questions
will be given by the delta of the delta tool that looks at the change in the
The change in the growth rate – the delta of
the delta growth stock analysis tool
For example, if Visa’s
growth, that is expected to be at 15% going forward, falls down to 10% per
year, everything would change from an investing perspective. This is counterintuitive
because 10% yearly growth is still amazing, but it might not be what is baked
into the stock price.
If Visa’s earnings grow 10% over the next 5
years, earnings per share would grow from the current $5.32 to $8.71 and not to
$10.70 as it would be the case with 15% growth.
You might think how this
doesn’t really make a great difference. Well, the change in growth makes all
the difference. The market is willing to pay a price earnings ratio of 33 for
15% yearly growth. If the growth falls to 10% and the growth trend is slowing
down, the market might want to pay a price to earnings ratio of just 20 for
that. Thus, in five years, earnings per share of $8.71 with a PE ratio of 20
would lead to a stock price of $174, a stock price close to current levels.
This would meand investors would look towards zero returns in the coming 5
years, despite the fact that the company is still growing at 10% per year.
The same works on the upside
too. If Visa manages to grow at 20% per year, earnings per share would go from
$5.71 to $14.2 over the next 5 years and the market would probably value the
stock with a PE ratio of 40 and the stock price would reach at an incredible
But this is the magic of
growth stocks and when you analyze growth stocks, the key to watch is the
change in the growth rate, i.e. the delta of the delta.
Growth stock analysis conclusion
The best way to apply the
delta of the delta growth stock analysis tool is to use it for investment risk and
What is the
probability that Visa growts at 20%?
What is the
probability that we have a global slowdown over the coming 5 years and that
Visa’s growth falls to single digits?
The delta of the delta growth
stock analysis tool gives you a range of what you can expect qua valuations,
stock price targets and investment returns in relation to the growth rate.
Growth impact on stock price:
If the growth matches the
growth expectations, the stock price will likely grow at the same rate of the
Growth rate beats
If the growth rate beats
expectations, the stock price will likely growth even faster as investors will
give it an even higher price to earnings ratio in expectations of even higher
earnings in the future due to faster growth. This is the case where Visa stock
can easily grow form $178 to $568 over the next 5 years.
Growth rate below
If the growth rate falls
below expectations, all the exuberant fellings quickly turn cold, the market
gives a much lower valuation to the stock and consequently the stock price can
fall a lot. This is why investing in growth stocks is considered risky and why
investors expect a high return when doing so.
I hope this helped to
increase your tool box when it comes to investing. It is a simple technique but
so important when it comes to assessing investement risks and rewards of a
growth stock. If you with to learn more, please check my FREE Comprehensive Stock Market Investing Course – did I mention it is FREE? It has many similar
lectures, both in video and written form.
If you wish to look at the best stocks I find through research and analysis, take a look at my portfolios, check my Stock Market Research Platform. There is a 28-day money back guarantee policy so even this can be FREE if you wish so.