Image source: Getty Images
One of the most important advantages ordinary investors (like me) can have is a long-term focus. This makes finding investment opportunities a bit easier – especially when it comes to growth stocks.
There are a number of extremely high-quality UK shares that I don’t think make much sense over a 10-year timeframe. But over the course of 30 years, the equation becomes much more favourable.
Investment returns
Whether it’s growth or income, investors looking for stocks to consider buying have to compare the likely return with what they can get elsewhere. And that includes investing in things like bonds.
Right now, a five-year UK government bond comes with a yield of around 3.9%. In other words, someone who invests £10,000 today could expect to get £1,950 over the next five years.
Over a much longer timeframe, a 30-year gilt comes with a 5.2% yield. Investing £10,000 at that rate could realistically return £15,600 between now and 2055.
Given that equities are inherently riskier than bonds, investors should look for a better return from any stocks they consider buying. And that sets up an interesting dynamic for growth stocks.
A FTSE 100 giant
One example is Experian (LSE:EXPN). The firm recently released its results for the 12 months ending at the start of April, where it generated $1.4bn in free cash flow – roughly equivalent to £1bn.
The company currently has a market value of £34bn, so that implies a return of just below 3%. In other words, it’s going to have to grow significantly to be a better investment than a bond.
To return more than the five-year bond, Experian’s free cash flow’s going to have to grow at 15% a year. That’s possible, but the rate required to outperform the 30-year gilt is less than 4% a year.
In other words, the stock has a much better chance over a longer time frame. In fact, I think it’s almost impossible for the stock to do better over five years without outperforming over 30.
If Experian grows at 15% a year for the next five years – the rate required to outperform the short bond – annual free cash flows should reach £2bn. But that’s a 5.9% return at today’s prices.
From there, the business would have to go backwards quite significantly to underperform the 5.4% annual return from the 30-year gilt. And I think this is highly unlikely.
Risks and rewards
When it comes to stocks, there are no guarantees. And with Experian, one of the key things to keep an eye on is the regulatory environment in the US.
The situation has shifted from one where the company’s data was required for lenders to one where it’s strictly optional. That makes the environment more competitive than it once was.
Experian has responded well to the challenge so far, with a unique product that offsets significant risks for lenders at a relatively low cost. But investors should still be aware of the potential risks.
That might create enough uncertainty over the short term. But for those with a longer horizon, I think the low required growth’s something to pay attention to.
