One of the commonest mistakes retail investors make is to believe they’ve ‘missed the boat’ on the best long-term growth stocks. In other words they believe it’s ‘too late’ to buy stocks at record highs as anchoring to past prices convinces them that the shares are ‘too risky’.
This is a common psychological flaw to avoid as it can lead to excluding yourself from the very best long-term growth stocks that commonly tend to hover around 52-week highs.
On the other hand another common mistake investors make is paying too much for wildly popular growth stocks that have exceeded fair value.
This mistake can lead to you being underwater for a long time on your investment and produce disappointing returns, but assuming the underlying business continues to perform you may eventually turn a profit on your investment. Be warned though because buying a business on a high valuation that repeatedly disappoints could see you burn your capital quickly.
One stock that tends to hover around record highs that I think may still produce strong long-term returns for investors is CSL Limited (ASX: CSL). Below I give five reasons why this may be the case.
- Underlying demand for its core blood or plasma therapy products used by hospitals remains strong with public healthcare spends globally on an upward trajectory. I’ve written before about how many national governments could double their total healthcare spends tomorrow and there would still be loud calls and pressure for more spending. CSL and its products are perfectly positioned to benefit from the endless demand to increase public healthcare spends.
- Earnings moat – Warren Buffett often suggests that the most important qualitative aspect to look for in a company is its ability to consistently raise product prices without impacting underlying demand. Note his recent investment in Apple Inc. CSL also appears to have genuine pricing power thanks to the scientific complexity of its products and the regulated space in which it operates. The group has competition from large rivals which is a risk, but that competition does not appear to be eating into profit margins. If anything, CSL is also growing market share.
- Management – CSL’s management has been criticised historically for inflating earnings with too much debt, but I think its management has a second-to-none track record in responsibly growing a blue-chip healthcare business. The current CEO has been in the role 5 years and joined a CSL predecessor company as far back as 1997. The former CEO from 1990 to 2013, Brian McNamee, is also a current board member. So while not “founder-led”, CSL does retain its most successful and experienced management over the long term, which is a quality of the most successful growth companies.
- Growth – this might sound obvious, but CSL (market value $83 billion) is now a larger company than Australia & New Zealand Banking Group (ASX: ANZ) and National Australia Banking Ltd (ASX: NAB). And not for nothing either. It’s because it has been able to consistently deliver strong earnings per share and dividend growth over the long term. Investing is not rocket science and companies that consistently grow profits will eventually be assigned higher valuations by share markets. Importantly, CSL invests a lot of its operating profits in research and development to deliver the big selling products of tomorrow. Currently, it has 37 different products in the pipeline or initial post-launch phase. These include CSL 112 and CSL 324, the former touted as a potentially big winner as a therapy for treating patients that have suffered heart attacks.
- Valuation – CSL delivered FX-adjusted earnings per share (EPS) of A$3.88 in FY 2017 and delivered FX-adjusted EPS of $A3.16 in just the first half of FY 2018 in a result that is impacted by the seasonality of flu seasons. It’s guiding for full year profit growth around 20% if profit comes in around US$1,600 million as forecast. Analyst consensus has FY 2018 EPS to come in at A$5.22 and FY 2019 at $A5.75. In other words the stock at $183 is changing hands for around 31x analysts’ forecasts for strong EPS growth out to FY 2019. That’s expensive, but not too expensive given the quality and momentum behind the business.
I expect the stock can go far higher in the decade ahead.
There are substantial risks though around the aggressive valuation that is likely to tumble if CSL cannot deliver more strong growth out to 2020.
While the company operates in a moderately competitive space that could see its margins or market share suffer. It also carries a significant amount of debt that makes it vulnerable to rising interest rates and amplifies the downside if the company does not deliver operationally. As such CSL should only make up a small part of a balanced investment portfolio.
CSL is a blue-chip of today unlike the big banks which are looking like yesterday’s blue chips.
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Motley Fool contributor Tom Richardson owns shares of CSL Ltd and Apple inc. The Motley Fool Australia owns shares of National Australia Bank Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.