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The Concept of the Nine-Box Matrix
Overview: The following is a brief summary of the concept
of the Nine-Box Matrix. It defines the parameters of the playing
field for High Growth Stocks, and focuses on the most important
ingredient, the earnings growth of a stock in the short and long
term. I am asked from time to time what prompted me to derive the Nine-Box Matrix, its various elements and how did it all come about. So here for posterity sake is the folklore behind it that will find its way into the Book of Lore someday. The objective of the Nine-Box Matrix and its appendages was to: 1. Help people who are new to HGS Investing to ballpark their investment
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For those who are new to HGS Investing, and understand the specific requirements of Earnings Growth for both 5 Years Annual and two most recent quarters, compared to a year ago being high, I devised a simple way for you to pigeon hole these stocks into boxes. The concept is based on the fact that higher is better, and the cream always rises to the top. It also pre-supposes that you know the rule of 72! The rule of 72 states that for a given compounded Interest Rate dividing 72 by that rate will give you the number of years it will take for a security to double. Thus, if the bank was generous to give you 7.2%/year on your money (you wish!), it would take you ten years to double it. If it gave you 10%/Year, it would double in 7.2 years. Worse yet, if they gave you on average only 4% a year, it would take 18 years to double your money. Hence it is imperative that you put SOME of your money into higher risk securities if you are to enjoy a nest egg that will cover your retirement years in comfort. That said, we can construct the Nine Box Matrix by using three levels for 5Yr. Annual Growth and again for two qtrs, this qtr vs a year ago, and last qtr. vs a year ago. (See the diagram below). Box 1 has the biggest growers. If by chance they produced exactly 72% a year growth, it would take those companies in Box 1 to double in 1 year. Likewise, between friends in terms of the math, Box 5 will double in two years and Box 9 stocks will double in three to four years.
If you were to take a big enough sample over the years, Box 1 should provide the best Price Performance while Box 9 the least, though realize, substantially better than the rest of the field that don't even make it into this Matrix. The important point here is that the Nine-Box Matrix describes the "diamond" on which your ballgame is being played. Stray outside it in your selection process at your own peril. That is not to say there won't be stocks that perform better that don't meet the requirements, but it does imply that the odds are slimmer, since Wall Street usually rewards superior earnings performance with superior price performance. Life is never that simple. There are always exceptions to the rule. You will also find that Wall Street rewards high revenue performance for up and coming new companies who have not as yet been around long enough to establish a solid 5 Yr track record, or those who have stubbed their toes in a poor period but in the last two quarters have come back with solid growth rates >100% in each qtr. So watch for Box 7 stocks.
Lastly, these budding New America stocks move out to Box 10 as they go through their stages of growth to maturity and finally become stalwart Gorilla Large Cap stocks. They are the slower turtles that may not provide as high reward quickly, but provide CONSISTENT Earnings Growth quarter after quarter, year after year, like Abbotts Lab has done for years. This is Box 10 for the Mattress Stuffers. But there is one more criteria one always needs to be aware of if you are to keep the profits that you make…..the Market. When the wind is at your back, play; when you have a strong hurricane in your face, run for cover. Cover in our vernacular is Box 11, All Cash! Unless one is an extremely good stock picker, you usually lose money when the market is so weak as to have given an Intermediate Correction which is >12% from its most recent high, and worse yet when it is down >16 to 20%, when it is a Major or Bear Market correction. Not difficult when you remember three things:
A Filter that captures the Nine-Box Matrix and the Green Sea Stocks
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