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The Miracle of Compound Growth

Posted
1/14/2013 2:52:00 PM
By: Cabot Heritage Corporation
Referenced Stocks:CSC;EFX

The Miracle of Compound Growth

Tax-Free!

10 Stocks to Hold Forever - Part Four

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In recent weeks, I've been writing a series called "Ten Stocks to Hold Forever." You'll find the fourth stock of the series discussed below, and background information on Ten Stocks to Hold Forever here.

But first I want to spend a little time illustrating WHY holding a great growth stock forever can be smart. So without further ado, I'm proud to present "The Miracle of Compound Growth."

Imagine you start with $10,000. By following a proven investing system (mainly investing at the right time in a great growth stock and holding on) you're able to double it, to $20,000. That's pretty good, but it's not great.

But then, by dint of more excellent stock-picking, combined with a great bull market and a fair dose of patience, you're able to double your money again, and again and again. At this point, your $10,000 has metamorphosed into $160,000, for a gain of 15 times your original investment. It's almost magical how this works! Yet very few people are aware of this possibility and even fewer attempt it.

And why not?

Excessive focus on the present is certainly one reason. You can blame the media-in part-for that.

A lack of education about this miracle is another, and that's a shame.

Because the numbers don't lie, and if you have any doubt, I urge you to run the numbers for yourself. The exercise can be eye-opening.

Now, there is one more reason that very few people are able to multiply their investment 15 times, and it's that old bugaboo, taxes.

Whenever you take a profit, the taxman wants his share. (The exception is tax-advantaged retirement accounts.) Thus, if you achieve this feat of doubling your money four times (in four separate investments), but pay a 20% tax on your capital gains after each sale, you'll end up not with $160,000 but $104,976. That's still great, but it's not as great as $160,000.

You can see the difference here.

Compound growth chart, Equifax

So, for any account subject to capital gains, it makes sense to avoid taking gains whenever possible. And the best way to do that is to never sell!

But not selling only makes sense if your investment still has the potential to double in a reasonable time. And that means you want to focus on stocks with major long-term growth potential, stocks with the potential to change the world. (Doing so, said author Tom Phelps of "100-to-1 in the Stock Market," will allow you to benefit from the "unforeseeable and incalculable.") These are not your solid, dividend-paying blue chip like Johnson & Johnson and General Electric and McDonald's; their best growth days are long behind them.

No, you want to own the next McDonald's (maybe it's Chipotle), the next General Electric (maybe it's ARM Holdings) and the next Johnson & Johnson (maybe it's Onyx Pharmaceuticals.)

All those potentially great growth stocks have been recommended by Cabot advisories, but today I'm not writing about them. Instead I'm sticking with the list of ten stocks created by the Cabot editors, and today I'm focusing on a stock chosen by my daughter, Chloe Lutts, who's editor of both Dick Davis Investment Digest and Dick Davis Dividend Digest.

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The stock is Equifax ( EFX ) and it was originally featured in the November 7, 2012 issue of Dick Davis Investment Digest, after it was recommended by Charles B. Carlson of DRIP Investor.

Here's what Carlson wrote.

"Among my Editor's Portfolio stocks, none is probably better situated for short-term gains than Equifax, Inc. The firm is a leader in information solutions, leveraging one of the largest sources of consumer and commercial data. The company provides consumer-credit information, business-credit intelligence, fraud detection and various marketing, human resources and e-commerce services. The stock, which has been especially strong in recent months in moving to an all-time high, has much to recommend it at this time: An uptick in the housing and rental markets should spur increased demand for the company's various consumer-credit services. Record per-share profits this year and next should provide support to the stock. And dividends should grow by double digits over the next 12 months.

"I've always been a fan of companies that control large amounts of data. Profit margins are typically high for such companies that can generate a constant stream of new products and services from a vast database of information. Equifax is the poster child for such a business. To be sure, the firm is not without its risks. Given the nature of its business, Equifax is vulnerable to governmental investigations and potential increased regulations as to how its data can be used. The firm recently agreed to pay $393,000 to resolve allegations it broke the law by selling lists of consumers who were late on their mortgage payments. The company's business is also vulnerable to recessions, as evidenced by the stock price falling below $20 during the 2008-2009 economic downturn.

"Still, consumers remain engaged at this point judging from their spending patterns in recent months, and lending should loosen up a bit in 2013, which would be a plus for the firm. Admittedly, the stock, trading at 17 times 2012 earnings estimates, is not cheap. However, I would not be surprised to see these shares continue their upward momentum for the remainder of this year."

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When Carlson wrote that, EFX was trading at 50.61, and it stayed in that range through November, when it was featured in Dick Davis Investment Digest.

Then on December 3, Equifax announced it would acquire the credit services business of Computer Sciences Corp ( CSC ) for $1 billion, and investors cheered the deal, driving the stock up from 51 to 54 on very high volume (and proving Carlson very right in the process). It spent the rest of December consolidating that gain, but the first days of January saw it climbing again; last week it hit 56!

Short-term, a pullback is always possible, but long-term, Chloe likes EFX because of its dominant presence in the industry of consumer credit information. She likes it because the company, with 25% of its business coming from outside the U.S., has great global growth potential. And she likes it because with annual revenues of just $2 billion, the business can get a whole lot bigger.

Now, you could just buy EFX here and put it away for ten years. My guess is that would work out pretty well. But ideally, you should get on board at a lower-risk entry point, and for guidance on that, you can hardly do better than to heed the recommendations of Mike Cintolo, who's editor of Cabot's flagship investment advisory, Cabot Market Letter.

Yours in pursuit of wisdom and wealth,

Timothy Lutts
Editor of Cabot Stock of the Month