 Good day fellow investors, my name is Sven Karlin and today we are going to discuss how to analyze growth stocks. In this market 8 years, bull market, everybody, everything is all about growth stocks. However, some value investors might say they are overvalued Amazon price-to-earnings ratio of 288, but perhaps there is a method behind that madness of extremely high price-to-earnings ratios. So today we are going to discuss what is the most important metric to look at when analyzing growth stocks and that is the change in the earnings. Earnings are always expected to grow at a linear rate or analysts estimate a little bit here or a little bit there. However, it is impossible to accurately estimate future earnings of a growth company. So even small fluctuations in earnings on the positive side beating expectation or being below expectations, that affects hugely the stocks. We are going to see how that change in earnings, the delta of the delta, you might call it affects the stock price and why it is so important and what to look at. Just a quick look at Amazon, the market capitalization is 456 billion, the revenue is 161 billion, the net profit margin is 0.003% extremely small. However, the growth in revenue for the previous three quarters was 23%, 24% and 35% respectively. So let's imagine Amazon manages to grow its profit margin to 3% and grow at 27% per year for the next 10 years. After 10 years, Amazon's revenue would be 1.7 trillion and the net income with a 3% profit margin would be 52 billion. 52 billion, 546 billion the market cap, then you would have after 10 years a price to earnings ratio of 10. However, there is also something else that's very important when looking at growth stocks, not so much earnings as price to cash flows. Cash flows are key when analyzing growth stocks because there is a lot of investment, there is a lot of marketing depreciation that is expected to give benefits as the company scales thus increase the margin. Amazon's operating cash flow is 16 billion which is 10% of revenue so the price to operating cash flow is 34. That is not that high so there is a key metric for Amazon I think. Nevertheless, the main question for Amazon is whether and how fast the company will continue to grow. I'm sure Amazon will grow for the next 10 years but the question is how fast. So let's say the last quarter Amazon grew 34%. In the previous quarters 24 25 for an average of 27%. Now we can think that investors expect Amazon to continue to grow at 27 30% perhaps even a little bit more. Let's see how that affects the stock price. So if you look at Amazon the five-year chart 2013-14 it went almost to 400 then it dropped to below 300, 290 at one point then it went up to 600 something below to 500 again. You can see a lot of shocks 800, 700 and now it stabilized after the shock when Amazon reported 33% growth after that positive shock it stabilized to 1150 where we are. Now however you can see that there are sharp declines like the one in 2014, 2015, 2016 there are sharp declines and that happens whenever Amazon misses on the growth estimates. So when there is a miss you see a stock price decline significantly. When there is a bit the stock price surges. That is why growth stocks are considered risky. There is a big difference in the current valuation of Amazon if it grows 27 or 20% huge difference in the stock price. Let's see. Let us imagine that investors expect Amazon to reach a five-year forward price to cash flow ratio of 10. Thus in 2022 Amazon's operating cash flow should be at 56 billion and revenue at 56 billion. This would mean that Amazon would have to grow at 28.4% over the next five years with the operating cash flow margin equal. Now if Amazon slows down just a bit let's say to 23% thus the slowdown in growth is 20% which would still be a staggering number the calculations change abruptly 2022 revenue would be 450 billion and operating cash flow 45 billion which is then a 20% decline and you can expect a similar decline in the stock price but that's not it there is more. I said that the forward five-year price to operating cash flow ratio is let's say 10 but if growth slows down by 20% then the growth rate doesn't justify the five-year forward price to cash flow ratio of 10 that has to be lowered too. So let's say it's lowered by 20% to 8 so if I multiply Amazon's five-year forward operating cash flows with 8 the lower case cash flows I don't get the current market capitalization of 540 billion but 360 billion. So a 20% slowdown in Amazon's growth from 28% to 23% would lower the stock price by 35% so that's a huge huge number and it shows how risky are growth stocks we haven't seen a recession in eight years the global economy is doing good so there are a lot of positives in those prices so you have to be very very careful. One recession you can see what's the impact of just slower growth I'm not talking here about no growth about losses no just slower growth from amazing 28% to amazing 23% stock price drops 45% so be careful of that when analyzing growth companies however the trick works the same in the opposite way as Amazon did beat earnings expectations and grew above 40% the stock price immediately jumped from 950 to 1150 that's how world street works and that's how growth stocks are analyzed so if you can see okay this company is going to grow faster than expected or slower than expected that's the key when investing in growth stocks if you can do that well then you don't need anything else in life. Thank you for watching looking forward to your comments are there any growth stocks that you are analyzing does this method apply the change in the growth and how would that affect the stock price I'll see you in the next video