The Ambergris Factor

In the American whaling industry, which got underway during the eighteenth century, whalers slaughtered the giant Sperm whale for sperm oil, which came from the head and blubber and was important as a fuel for lamps. Another type of oil, called spermaceti from the head, became the chief ingredient in candles. While boiling up the blubber and parts of the Sperm whale, whalers occasionally noticed a very pleasing fragrance. It turns out this was a third oil-like substance, located in the intestines of the whale. Called ambergris, it became the basis for very expensive perfume. The problem was that the whalers found ambergris in very few of the whales they killed; nevertheless, the substance brought them a good income because the perfume manufacturers paid extremely high prices for it. So the whalers killed a lot of Sperm whales looking for those chosen few who had the right stuff.

. . . The Fall of 1st Executive, by Gary Schulte

Ladies and gentlemen, investing is a lot like whaling. Investors are constantly searching for that whale of a stock with the “right stuff” . . . aka the “ambergris factor.” Indeed, there have been many such “whales” on the Street of Dreams since the Royal Bank of Scotland’s “sell everything” advice at the January/February of 2016 stock market lows. The problem with some of these “whales” is that they have become so large they are going to have a tough time continuing to grow at their previous rate; and, that’s the key, G-R-O-W-T-H. On Wall Street “growth” is the pleasing fragrance that brings in buyers and makes stocks go up and way up! Moreover, growth and growth rates is what legendary investor Peter Lynch looked for in selecting stocks. As he explained in his book One Up On Wall Street, it’s all based on the arithmetic of compound earnings. To wit:

All else being equal, a 20-percent grower selling at 20 times earnings (a PE of 20) is a much better buy than a 10-percent grower selling at 10 times earnings (a PE of 10). This may sound like an esoteric point, but it’s important to understand what happens to the earnings of the faster growers that propels the stock price. Look at the widening gap in the earnings between a 20-percent grower and a 10-percent grower that both start off with the same $1 a share in earnings:

At the beginning of our exercise, Company A is selling for $20 a share (20 times earnings of $1), and by the end it sells for $123.80 (20 times earnings of $6.19). Company B starts out selling for $10 a share (10 times earnings of $1.00) and ends up selling for $26 (10 times earnings of $2.60). Even if Company A is reduced from 20 to 15 [times earnings] because investors don’t believe it can keep up its fast growth rate, the stock would still be selling for $92.85 at the end of the exercise. Either way, you’d rather own Company A than Company B. This in a nutshell is the key to big-baggers [the ambergris factor], and why stocks of 20-percent growers produce huge gains in the market, especially over a number of years.

Admittedly, it’s extremely difficult to find consistent 20-percent growers and to then have the courage to hold them for the long-term. But from a portfolio point of view, if you keep eliminating the stocks whose growth rate falters, you will avoid the “blubber” and be left with the “ambergris,” the chosen few which may turn into the 20-percent growers – the key to huge stock market gains.