Ask Colin

Isn't Vocus Communiacions a growth stock?

The detailed question was:

I was surprised to see you sell half your holding in Vocus Communications, but can understand your logic.   I was wondering if you ever “re-rated” stocks from Value to Growth and hence *may* have held this stock longer?   I noted your initial analysis that questioned whether Vocus Communications was a growth stock in which case a high P/E ratio would be justified.  Given they are looking to takeover AMM, and they already pay a low dividend, wouldn’t that classify it as a growth stock?

 

There is a difference between a growth model chart and a growth stock. What I said was that there was potential for the chart to become a growth model chart, but there is simply not enough history to do that. We really need to go through a bull-bear market cycle to be sure.

 

In discussing the PE ratio I observed that it was high for a value model stock, but would have been alright for a growth model stock. That is not to say that it was a growth model stock.

 

All that said, there are some crossovers in that growth model charts are often associated with what are commonly called growth stocks.

 

The key issue with Vocus is that it is an unseasoned business that is way overvalued. A critical part of my risk management is to buy stocks with a margin of safety and Vocus no longer has that. This is why I have a profit-taking strategy. Each time a stock doubles, I sell half of it. In this case I sold half twice, because it has become so overvalued and higher risk.

 

Ramsay Health Care, which is also in my portfolio is also a growth model stock and I have sold half of it once. It also looks somewhat overvalued, but it is a great business that just keeps performing over many years.  It has also maintained a ROE in the mid to high 20% range. That is well above my cost of capital and hurdle rate.

 

Compare that to Vocus Communications, which has a declining ROE of 13.3%, just above my cost of capital, but below my hurdle rate.

 

That is why I have a large holding in Ramsay Health Care and am reducing my exposure to Vocus Communications. Remember that investing is about part ownership of a business. Which of the two would you want to be a part owner of?

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