How I Choose Growth Stocks to Maximize Long Term Returns

Simon Erickson

United States
Long-Term Investor

Who are you and what’s your story?

I am Simon Erickson and I am the founder and CEO of 7investing. The backstory I like to tell is that I have always made my money by reading the tea leaves of the future and my paycheck has depended on that.

I spent my 20’s as a technical sales rep, I was flying around the country and racking up frequent flyer miles and staying in hotels in different cities and seeing the new products that a whole bunch of companies were developing. Especially chemicals for organic agriculture, demulsification, and hydraulic fracturing in the oil and gas industry and personal care. But the common thread was it was always the forefront of the new products that everybody wanted to make that they could sell at higher prices and get higher margins for.

And so, I continued that love of innovation and got an MBA in entrepreneurship and then went out and worked for a large oil company and developed their renewable energy strategy. We built a whole lot of solar projects and they had some deep pockets to fund that, which was fantastic because you could see some progress from it.

For the last seven years, I worked for the Motley Fool as an advisor for a service called Motley Fool Explorer. We looked at some of the innovative trends taking place, but instead of doing it internally with a company, where you are developing those projects operationally. I was on the outside looking in as an investor and finding the companies that were really poised to take advantage of these larger market trends.

And here we are today, 7investing launched in March of 2020, so we are approaching our first birthday.

We are a team of advisers that is going out and finding what we believe are the best opportunities in the stock market. Every single month, we find our seven best stock market ideas, package those together into a subscription product and make it available for $17 a month.

We do not just focus on one type of investing, we want to have the full buffet of options for different types of investors. We think it is a personal thing, for example, if you are 65 and going into retirement, you are probably looking at the stock market very differently compared to if you are 22. So, we want to find types of investing that appeal to growth style “swing for the fences” investors, but then also investors that are more interested in value or income.

To do that, we have a team that looks at very different sectors of the market. Some of our advisors are really into biotechnology and genomics and they are really looking at what is going through FDA trials and clinical trials. They’re looking at what do areas like CRISPR gene editing, or CAR-T Gene Therapy mean for this world of Life Sciences.

And we have other advisors that are looking at artificial intelligence and cloud computing, these are really big changes in how software is being delivered across the internet and in a much more efficient way.

And then we have certain advisors like me, who are really interested in disruptive innovation and why is it that big companies just don’t keep getting bigger and bigger and why do you have small companies that can topple those.

Finally, we also look at other areas like digital payments.

We look at markets and try to work out where the competitive advantages are and also how they are changing, and who are the innovators in those spaces.

As a corporate employee, my first experience with investing was funds that were available for 401k plans. You had a shortlist of the funds you could invest, it would be a growth fund, value fund, income fund, etc.

You basically had this chart that showed every fund, the one-year return, three-year return, and ten-year return. You did not actually know what was in the fund, you only knew what the strategy and what you were going to get charged for it. And by the way, “do not ask any other questions. Just accept the rest of the fund for what it is.”

That was the first experience and over time, I asked myself “why is that the number of the annual return we are getting?” and “can we get better returns than that if we find the better-performing companies in there?”.

And so I started to do a little bit more research into what was going into these funds and that led me into looking into individual companies.

The very first individual stock I can remember buying was Monsanto, which is an agriculture company. Probably not the greatest investment for a long-term investor as it was for the most part a commoditized industry. But it opened my eyes to this world of the stock market, and how I could participate in it as an individual.

Walk us through your process of identifying and executing on investment opportunities?

I tend to first look at what is going on in the market, I am a self-proclaimed growth investor which means the companies I want to invest in have not yet begun to hit anywhere near steady-state and their company lifecycle.

They are just getting started and they are disrupting these markets that need to be disrupted.

To do that, you’ve got to start it at the market level. It brings me back to being a sales rep and going out and talking to people and seeing the truer picture of what is going on out there.

As an individual investor, this starts in technical conferences, MIT conferences, and others that are academic in nature, where you have PhDs, postdocs, and really smart people saying;’ “Hey, here’s what I am developing, to serve the needs of whatever market it is.”

Every market that’s changing is doing so because there are pain points. Something is wrong and needs to be fixed.

And the companies that respond to those, I believe, will outperform the market because they are listening and developing innovative solutions. I am looking for long term capital gains from companies that aren’t in a steady state. They aren’t paying dividends, they aren’t necessarily buying back stock, but they’re going out and they’re plowing it back into R&D and capturing those changes that are taking place. 

Quantitatively, you definitely want to look at top-line growth.

Is this company growing revenue at 40% or is it growing at 2%?

If you’re trying to disrupt a market and growing 2% something is not working. Whatever you’re doing is not being responded to.

The other thing that I look for is companies that can scale their organization, and what that means checking if their operating margin is increasing over time.

That means that in addition to them selling more, they are actually getting their costs under control.

Whether that’s their R&D spend, their sales, and marketing efficiency, or their overhead. Expenses like that should be decreasing or should be growing at a slower rate than the revenue is growing.

And if you do that you capture a higher and higher slice of the profit pie and you can share that with investors in creative ways going forward.

That is the science part of investing, about the art part, which is assessing management asking, how leaders of these organizations are going out there, and capturing these opportunities in a way that is good for individuals or the investors in the company.

This is where it gets a little squishy sometimes, but you look at the definitive proxy statements, their share-based compensation, their own ownership stakes, their plan of action, the efficiency of their R&D projects from five years ago, and whether they’ve done well with those.

It is no, one size fits all, but if you find the right kind of industry at the top and you start finding some companies that are addressing those pain points, and then you drill down to their performance quantitatively and qualitatively. These exciting opportunities start to emerge.

In terms of timeline, for example, my pick this month, which I cannot disclose, but I will say it is a cybersecurity company. I looked back on notes that I took from a cloud expo conference in 2018.

I think of investing as when is the time really right. You have to build a watch list and unless you’re worth hundreds of millions of dollars, you probably cannot buy all of them.

So you have to ask yourself which ones do I really, really want?

And then make a judgment on what you think the best opportunity is at any given time.

It could be years, for example, there are companies on my watch list that have sat there for two or three years that I never invested in and never made a recommendation, until either the valuation was in the right place, or the market was in the right place, or something was a catalyst that said, this is the time.

What do you look for to find good investment opportunities?

This goes back to the art versus the science of investing.

There are some hard numbers that are important, you want to look at:

  • Revenue growth
  • Operating margins
  • Cash flows
  • Free cash flows

All these numbers are important but I think that they’re the exhaust coming out of the tailpipe of how the car is being driven.

We pay too much attention looking at the exhaust pipe rather than looking at the front window of the driver.

That’s the art of investing, are you a CEO of a company that is slamming on the accelerator and not producing any cash, and consuming a lot of cash, and raising debt? 

Because if you are Elon Musk and you are the pilot of Tesla, and at this point, it is not even a car, let’s call it a rocket, it is just growing so quickly but then the advantage is that it is growing in this capital-intensive industry where it is locking out its competitors. Traditional automakers are not going to be able to compete with Tesla at its valuation right now.

Tesla can raise $50 billion and other automakers cannot raise that kind of money to build super capital-intensive electric vehicle lines or supercharger networks and all the other infrastructure.

I am digressing a little bit, but the important point that I am making is that investing is more than just the numbers at any given point in time.

You have to appreciate the market conditions and ask yourself what strategy is the leadership taking?

The greatest investment stories are fantastic leaders who are allocating capital to the most promising opportunities.

They are not only visionary, but they’re willing to put money into what they believe in. For example, Jeff Bezos is willing to put money into Amazon Web Services to develop cloud computing.

These are the stories that make investors that are in it for the long term able to compound those returns. You can get 100 baggers out of companies who stick around for the long term and then you retire on a small island in the Caribbean.

Those are the kinds of companies that I think are the most interesting out there, rather than just running a filter or a screen based on dividend yield.

I think that a lot of the quantitative investing is a little bit too narrow and focused, and the really interesting part is when you look at the more creative things that are going on out there that are not understood by the majority of institutional investors.

I would recommend investing in specific stocks because it gives you much more control as compared to investing in a growth ETF. ETFs mimic the index put together by an investment manager, meaning you’re following their specific investing style rather than self-selecting companies of your own.

Since you first started, what have you learned that has had the biggest impact on your success and the growth of your portfolio?

The biggest lesson I would pass along is, do not sell your winners.

We tend to out-think ourselves and we think “oh, wow, the stock is up 100%, I am selling up and locking in profits”.

And then you just kick yourself seeing it go higher and higher because great companies outperform over long periods of time.

As an example, back at the bottom of 2008, I had an opportunity to buy into Amazon at $43 a share and sold it about eight months later for $87 a share, so basically 100% gain.

I thought I was brilliant with a 100% gain in a year and then look at today, Amazon was selling just recently at $3,333 a share.

How much upside did I miss out on by out tricking myself and telling myself to lock in those gains?

I was thinking way too short term, I was thinking of the stock market as an alternative to a bank account where rather than just keeping money in the bank.

In the short term, it looks great, in the long term, you realize what you are giving up and missing out on.

And that’s why we always say if you are going to invest, if you are going to put money to work in the stock market, do not think about it that way.

Think about it in terms of at least three or five years out and be very selective about the companies that you pick.

Do not just say, “Okay, I’m going to go out, I’m going to invest in, you know, 100 companies and put a small, little amount in each one.”

I think it is much more prudent to say, “I’m going to find maybe 15 or 20 companies and really have conviction in those.”

That is going to allow you to stick around and follow the conference calls and keep in touch with what they are doing.

That’s my approach to long term investing, think about it from a long term perspective. 

What books, platforms or resources have you found useful?

The first book that changed my life as an investor was the Innovator’s Dilemma written by Clayton Christensen.

He was a Harvard professor of strategy before that he was a consultant. He really defined what disruptive innovation is and how it is that a small upstart company can displace the larger companies that have just huge market shares and huge margins.

A large part of that is, they are more nimble and able to address the customer groups that are not being addressed by those large companies, who are focusing on their largest customers as they should.

A couple of professors also wrote the Blue Ocean Strategy, which is another great one too. This one addressed that if you do not have competitors, you can charge higher prices and capture better margins. So find the companies that are going out there and trailblazing new paths, because they are doing something new there, and they are absent of competitors for the time. And even better if it is an industry or a space that can grow over time, so they can always stay a couple of steps ahead of everyone else who is trying to catch them.

For daily news, I use Wall Street Journal all the time and MIT Tech Review for those longer-term crazy projects.

We use YCharts at 7investing for tracking financials and I use it for capital allocation when I am figuring out how companies are spending their money.

What advice would you give to someone who’s just starting out?

It’s interesting because when you first start investing, at least for me, you want to jump into the deep end really quickly. There’s so much excitement about buying stocks and you want to go out there and immediately make a lot of money and you start thinking about what you can use that for.

And I really would recommend taking the opportunity to start small and dip your toe into the shallow end of the pool before you do a cannonball into the deep end.

Every investor is going to make mistakes, and it is much easier to make mistakes at the very beginning and use the opportunity of those first years as an education.

It is totally fine to buy stocks, you can put $20 into a stock if that gets you following it and paying more attention to it because you actually have skin in the game.

And over time you can start identifying the red flags and landmines that are out there that perhaps on day one of you might not have been aware of. Things like excessive stock-based compensation, mistakes that management makes, excessive debt loads for a company.

Things like this build over time.

My advice would be to buy stocks, but do not feel the need to jump in too quickly, knowing that you will probably make mistakes. 

There is a ton of information out there, so start thinking about what is your process going to look like? What kind of investor are you? And then let that lead you, based on your risk tolerance or the industries you are interested in.

Things like that can guide your process that you can continually refine over time.

And there is no right way to do investing either. I want to make sure it is clear that we think it is a very personal decision and that can lead you to the companies that fit your style.

If you are a more conservative investor and you do not want to take a whole lot of risks, you’ll want to look for more established companies that have a ton of cash flow that they can just pay back to you as a dividend.

That is a less risky strategy than a company that is just starting new, and taking on debt to fund their internal operations because they are going to shoot for the moon.

One of the two of those is not necessarily right or wrong, you just have to make sure your investing style is aligned with the type of company you’re investing in, or you won’t be sleeping well at night.

What investment opportunities are you excited about at the moment?

I think there are blue oceans out there right now, there are these emerging industries that are just starting to be addressed.

One that we really like to look at is life sciences and drug development. This is not just subjective healthcare anymore, it is becoming much more personalized and consumers are getting a lot more access to data and that is directly correlating to their health itself.

And on the other side of that, you also have serious conditions. For example, Oncology is definitely taking a data-driven approach. Some of these treatments today are $400,000, but are those going to get down to a point that is much more digestible for insurers to pay for? If so, then this can save a lot of treatments and a lot of lives and something like that is very, very important.

We still know only a fraction of what we are going to learn about the genome. The medical community does not even really understand it. There’s just so much academic research going on into that and we are starting to see a handful of companies make it into the public markets that investors have access to. It is a pretty exciting time for Life Sciences. 

In addition to life sciences, I think programmatic advertising is one of those markets that is changing rapidly. Programmatic means there are algorithms that are placing advertisements across sites and we have seen this on the internet, it is basically how Google places ads all the time.

But there is another media even larger than desktop computers and the internet and that is television.

Television still operates under this linear model for decades where you have a bundled cable package, you are probably watching four channels, but you are paying for 100 of them. The most-watched channels are subsidizing the lesser watch channels, and you are probably overpaying on your monthly bill.

We see people cutting the cord and they are going a la carte; they are picking individual channels and we now have connected televisions that can actually tap into the viewing habits and the history of each person.

Advertisers now have a much more targeted opportunity to show you what they think would be a higher converting advertisement, served programmatically to you at the show level rather than the regional cable level.

Ad tech is the catch-all phrase to describe these platforms that are being built to match the advertisers with the publishers of the content itself. It is ROI driven, but it is moving very, very quickly, and you are seeing a lot of money moving from bundled cable to individual a la carte channels. 

On top of that, internationally there are so many opportunities in Africa, South America, and India right now. They are embracing smartphones, internet connectivity, online banking, and digital payments. All of these things have implications for the first movers who are grabbing market share as it is developing and as people are coming online in the first place. 

And so, what is that going to mean?

Is that going to follow the same steps as Amazon did in the United States and Alibaba did it in China? Probably not.

Can you share a story about an investment opportunity that you passed on and went on to grow beyond your expectations?

Yeah, I have got a couple of them. One that I passed on for valuation terms was with Shopify, I think that is an incredible company that is largely misunderstood by the market and I think it is going to grow alongside its customers as a challenge to Amazon here in the United States and Canada. I do not know how big this is in Europe.

I was short-sighted on that one, I am willing to admit defeat that I always said it was overvalued or the market capitalization was way too out of touch with the revenue it was actually producing. 

Then you get into the nitty-gritty of how it is upfront more of a fixed subscription and that is the lion’s share of what it is reporting. But over time, it is taking a transactional cut of the revenue. I was missing that the growth was really exponential because it was getting a larger and larger fraction of high margin dollars from that transactional side of the business. 

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Thanks to
Simon Erickson

 for doing this interview.

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