How Much Should You Pay for a Growth Stock?

Investing in great growth stocks is entirely consistent with buying only at a margin of safety. Growth, after all, is a component of value. We think the best growth stocks often present the widest margins of safety, especially if you catch them early. Rather than "paying up for growth," astute investors may actually be getting the best of both worlds--buying into fast-growing firms at discounts rarely glimpsed elsewhere in the market. Yet we're often greeted with intense skepticism--at best!--when we raise ideas like these with other margin-of-safety-oriented investors, especially more traditional value investors. So we've decided to plant a stake in the ground and examine the record.

We'd like to share some interim results from our quantitative growth investing research. We're studying the return earned by investors in a sample of 50 widely known growth stocks over periods starting in 1990, 1995, and 2000, in an attempt to increase our insight into growth stock valuation--and just how much you can pay for growth. Of course, there's no chance that we'll abandon our preference for investing with a margin of safety--this remains a core Morningstar principle. In our view, one of the most frequent investment sins is overpaying for growth. It's entirely unnecessary, as an informed investor is well positioned to determine when growth is attractively priced--and when it isn't. Margins of safety remain vital, but when it comes to the best companies, there's often more to consider than most investors realize.