Monday, June 8, 2009

Peter L. Bernstein, 1919-2009: Got Growth?

Are you a board member of a growth company? Or, are you a board member of a growth stock?

Interesting question. They're not the same thing, as explained eloquently by Peter L. Bernstein in a classic analysis published in the Harvard Business Review in 1956. That essay, titled "Growth Companies vs. Growth Stocks," is included in a collection of classic writings on investing called, fittingly enough, Classics: An Investor's Anthology (Dow Jones Irwin, 1989) — which, thanks to my membership in the CFA Institute, is one of my most-thumbed-through reference works in my library.

Bernstein died on June 5. His obituary in today's New York Times offers an excellent portrait of this seminal thinker on how markets work and of the many contributions he made to the investment management profession.

I just dipped back into his "Growth Companies" analysis for a nugget of insight useful to board members on the question posed at the top. Here is what he called his "two rather heretical" but "constructive" points of view:

1) "Growth companies constitute a very small and select rather than a broad and important roster of corporate enterprises."

2) "Growth stocks are a happy or haphazard category of investments which, curiously enough, have little or nothing to do with growth companies."

"The ability to create its own market," Bernstein wrote, "is the strategic, the dominating, and the single most distinguishing characteristic of a true growth company. ... In short, the real growth company is, to borrow sociologist David Riesman's phrase, 'inner-directed' rather than 'other-directed.' It is a nonconformist in economic society. It adapts the outside world to itself by creating something or a demand for something which did not exist before, instead of adapting itself to changes in the outside world. It does not necessarily grow faster than the economy as a whole, but it does grow faster than the markets in which its products are sold."

The "most important conclusion" Bernstein drew from his analysis is that "the term 'growth stock' is meaningless: a growth stock can be identified only with hindsight — it is simply a stock which went way up. But the concept of 'growth company' can be used to identify the most creative, most imaginative management groups; and if, in addition, their stocks are valued at a reasonable ratio to their increase-in-earnings power over a period of time, the odds are favorable for appreciation in the future."

And favorable odds for a stimulating and rewarding board experience. Something to think about from this heralded investment strategist as you take measure of your current board involvements or contemplate a future board invitation. There are not many growth stocks around right now in this economy, nor much in the way of growth, but there will be some day again.