Image source: The Motley Fool
In my view the FTSE 100 and the FTSE 250 They have some amazing growth stocks. Here are three of the best. Croda International, DiplomaAnd Take it right.
Are any of these worth investing in at today’s prices? I look to Warren Buffett’s advice to find out.
Buffet presentation
In the year 2000 Berkshire Hathaway At the annual shareholder meeting, Buffett said the following about growth stocks:
Now let’s take a company that doesn’t pay you anything and has amazing prospects, and you buy it for about $500bn. Now if you feel that 10% is the right rate of return – and you can choose the number – that means if it pays you nothing this year, but if it starts paying next year, it should be able to pay you up to $55 billion over time. every year. But if it doesn’t pay until the third year, it will have to pay $60.5 billion in perpetuity at current prices.
According to Buffett, whether or not a stock is a good investment comes down to the cash it generates. And in the time it takes for the company to produce the cash, it must produce more to justify the current stock price.
Assuming interest rates reach 4%, I think it’s reasonable to demand a 7% return to justify the risk of investing in stocks. So let’s take a look at how Croda, Diploma, and RhythmMove chart using Warren Buffett’s approach.
Valuing growth stocks
Croda shares are down 33 percent since the start of the year. As a result, the company now has a market value of 9.2 billion pounds.
At these prices, a 7% annual return would mean £644m in cash each year starting immediately. Croda’s annual free cash flow is currently around £145m.
Diploma has a market value of just under £3bn. The company’s stock price is down 30 percent since the beginning of the year.
To invest at these prices, Diploma would need to generate £210m of free cash a year. In the last 12 months, Diploma has generated £107m in free cash flow.
Finally, Rightmove’s shares trade at a price that represents a market capitalization of just under £5bn. It follows a 25 percent drop in the company’s stock price since January.
A 7% annual return represents £350bn of free cash flow per year. Last year, RhythmMove’s free cash flow came in at £191m.
2 growth stocks that I will buy today
I think Croda shares look expensive at their current price. Diploma and Rhythmov, on the other hand, look attractive to me.
An average return of 7% represents a 30% annual growth rate for Croda’s free cash flow. That sounds like a lot to me and I’m not ready to invest accordingly.
For Diploma and Rightmov, the equation seems more favorable. Free cash flow growth of 10-15 percent each year results in average profits of more than 7 percent for each company.
In my view, this kind of development is realistic. For this reason, I would be happy to buy Diploma or Rhythmove shares at today’s prices for my portfolio.