What kudzu taught me about investing

As kids, my younger brother and I spent some of the summer with our grandparents in rural South Carolina.

Their “town” had a flashing traffic light, my aunt’s convenience store, a Baptist church, and not much more. So we had to get creative about finding fun…

Like the day we walked down to a nearby lake with our BB guns to shoot at squirrels.

I remember rounding a bend, only to see kudzu everywhere. Trees, bushes, fences… They were all covered by the invasive, ivy-like plant.

So was an old, rusted-out car with just the windshield showing. I found that fascinating enough that, being a boy with a BB gun, I decided to shoot at it.

Repeatedly.

Unfortunately, as I learned hours later from my very displeased grandparents, it belonged to a neighbor who still valued the thing. So I was grounded for several days afterward.

But I went back when I could. Not for the car, mind you, but for that kudzu patch. There was something fascinating about it that I couldn’t explain until much later on.

As I now know, kudzu isn’t native to the U.S. It wasn’t introduced here until 1876, admired first as an ornamental vine and then used as food for livestock.

When the Great Depression hit, however, the federal government thought it could solve the enormous soil-erosion problems American farmers were facing, especially down South. That’s how tens of millions of seedlings were planted across 3 million acres…

Only to expand exponentially from there.

Kudzu, it turns out, can grow around 60 feet per year, climbing trees, buildings and, yes, rusted-out cars, too. Worse yet, the USDA now knows that it doesn’t necessarily eliminate erosion.

Sometimes it just hides it.

So what I was looking at that day was actually a vivid, tangible life lesson about how growth isn’t always good. It can actually be very deceptive at times.

Even downright dangerous.

Wall Street loves growth. The very word can send it into a state of euphoria.

It’s obvious why. That’s how money is made in the stock market: companies improving their revenue, earnings, store, subscription, and/or asset counts.

Yet only slightly less obvious is how short-term growth doesn’t always lead to long-term profits. Sometimes, like kudzu, it just covers up the rust.

Captivated by how much “more” a company has produced or acquired, investors too often forget to ask important follow-up questions. Like whether its debt increased in the process, its margins declined, or its returns on invested capital fell.

That's why I don’t just welcome growth for growth’s sake. I need to see revenue per share, free cash flow, dividends and, most importantly, intrinsic value per share increasing as well.

I like a pretty picture as much as the next investor. But it needs to stay pretty when I dig beneath the surface.

This is one reason I've always been cautious about acquisition-driven growth. The objective shouldn’t just be to acquire assets.

It should be to acquire worthwhile assets at attractive prices that generate valuable risk-adjusted returns.

That distinction is especially important when we’re talking about real estate investment trusts (REITs). They can grow pretty darn quickly, buying up billions of dollars’ worth of properties in very little time.

However, those acquisitions won’t benefit shareholders for long if they’re financed with expensive equity or significant debt. The cost of capital, acquisition yields, and internal rates of return all need to make sense.

In short, investors need to know how much incremental adjusted funds from operations (AFFO) each new investment generates.

When that’s done right, companies can improve their productivity, reinvest their cash flow, raise their dividends, and repurchase shares year in and year out. That kind of outcome doesn’t require explosive growth.

It’s smart growth that matters most.

It might seem counterintuitive – and it’s definitely not popular – but the truth is that good capital allocators know when to invest… and when not to.

Not every opportunity should be acted on.

Wise management teams understand that their dollars matter. Every single one of them. So they evaluate their options at every turn, weighing which will be long-term winners and which won’t work out well in the end.

If they pass up on one growth opportunity, they know they can invest those dollars elsewhere. Assuming they’re already paying dividends like most Wide Moat Research recommendations do, management could repurchase undervalued shares instead or reduce corporate debt.

Or perhaps they could simply set that money aside for a rainy day. Because sometimes doing nothing is the highest-return decision possible.

As I wrote back on May 7, wise investors wait for their “fat pitch.”

And he didn’t swing when it wasn’t.

So here’s the bottom line…

There are two types of growth: the kudzu kind and the kind that compounds. And they tend to look very different, both on the surface and underneath.

Kudzu growth involves rising revenue and a growing number of assets… but also more debt and shares outstanding. As a result, returns on investment capital (ROIC) eventually fall. And value per share?

Well, that doesn’t look nearly as attractive either.

Compounding growth, however, involves revenue, cash flow per share, dividends, and intrinsic value per share consistently increasing – all while ROIC remains high. That’s what tends to happen when the object isn’t to own the most ground but to own the most valuable ground.

You tend to appreciate the outcome instead of ending up having to admit that you spent time, money, and effort planting an invasive species.

I can still picture that field of kudzu today. It looked so green and vibrant and dominant. Yet all the while, it was destroying real value and worthwhile growth.

Since I don’t want to see that happen to my portfolio or yours, I’m careful to look for:

And then I give those companies something kudzu never cared to consider: time.

The most reliable wealth isn’t gained in a day, a month, or a year. It’s much more of a slow and steady process that might feel far short of “explosive”…

But it also lasts much longer than a mere moment. And isn’t that what counts?

As I learned from that kudzu patch, if you’re going to take a shot at something, make sure you know what’s underneath first.

(Especially if it belongs to the neighbor.)

Happy SWAN investing!

Brad Thomas
Editor, The Wide Moat Daily