Learn to Love Scale, Part 1

 | Aug 11, 2014 | 4:00 PM EDT
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Take the following message to heart from me, a value investor. The answer to finding outstanding investment return is growth. But I'm not talking about growth in the way many people consider growth. The key word is scalability. Businesses with the potential to truly scale up their business are going to deliver sizzling results.

There is a key differentiator between growth and scale. Growth is the ability to increase sales and profits. Scale implies that a business has the ability to penetrate existing or new markets in various ways that, in turn, deliver huge growth that is sustainable and profitable.

Consider the following actual numbers from a real life business. In 2004, the company had revenues of $8.2 units. Ten years later, revenue was coming in at more than $170 units. During those 10 years, the stock rose by more than 4,000%. This was not some tiny grain-in-the-sand small-cap. These numbers belong to Apple (AAPL) and revenue grew to $170 billion from $8.2 billion. Profit, on the other hand, grew to $38 billion from $276 million. That is scalability.

I like to study the best and, in investing, Warren Buffett is the best. Those who disagree can't deny he's one of the all-time greats (whether you think Jack Nicklaus or Tiger Woods is greatest golfer ever, they are immortal). If you consider what catapulted Buffett to being the best investor and one of the richest men in the world, it is that the businesses he invested a lot in had one thing in common: scale.

Take your pick of Coca-Cola (KO), American Express (AXP), GEICO, Wells Fargo (WFC) and even the Washington Post when he invested in 1973. Go back and look at 10-15 year revenue and profit numbers and look at the stock market returns. Every time, the answer is the same. Scale equals market-beating returns for a long time.

Scalability is what separates a good investment from a great investment. A scalable business allows you to buy it, sit it on for years, and reap immense returns over a fantastically long-period of time. Scale allows you to compound your money for a long time, all the while deferring your taxable gain.

In the coming days, I will share some thoughts on companies -- both big and small -- that appear to be very scalable. In the meantime, don't be afraid to think big while focusing on paying a fair price. 

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