In its purest form, value stock investing is buying stocks the purchaser believes are undervalued because operations are in some way broken, but in a way that is fixable, either by existing management or through a change of control–and are at a price that expresses disbelief that this will happen.

Growth investors, on the other hand, look for companies whose stocks appear to them to be undervalued because they think earnings will be stronger than the consensus expects and/or that they’ll be strong for a longer period than the consensus expects. In either growth case, the issue is the surprise, not the fixerupperishness of the firm in question.

A basic, and important, idea for growth stock investors is operating leverage. the notion that small increases in revenue can create unexpectedly high increases in operating earnings and net profit. A stunning recent example of this is Nvidia (NVDA), whose most recent quarterly results summary I’ve copied below from the company website (note: this is a stock I’ve owned for years. I’ve recently sold about 10% of my position because of its size).

Q4 Fiscal 2024 Summary

GAAP
($ in millions, except earnings per share)		Q4 FY24			Q3 FY24			Q4 FY23		Q/Q	Y/Y
Revenue	$22,103			$18,120			$6,051			Up 22%	Up 265%
Gross margin		76.0%			74.0%			63.3%		Up 2.0 pts	Up 12.7 pts
Operating expenses	$3,176			$2,983			$2,576			Up 6%	Up 23%
Operating income	$13,615			$10,417			$1,257			Up 31%	Up 983%
Net income	$12,285			$9,243			$1,414			Up 33%	Up 769%
Diluted earnings per share	$4.93			$3.71			$0.57			Up 33%	Up 765%

I’ve put the numbers I want to emphasize in bold in the rightmost column above..

Revenue was up by 265% yoy in 4Q24 and +22% QonQ.

Manufacturing expenses were down from a third of revenue in fiscal 2023 to a quarter this fiscal year, so gross profits ballooned in 4Q24 to 4x the level of the prior year. This was one source of operating leverage.

R&D expense, which is basically the only operating expense, was up by 26% yoy, again an increase far below the yoy gain in sales. This is the other.

The overall result was after-tax income up by 769%.

Arguably, and in hindsight of course, the key variable in 4Q vs. 3Q is the 22% QonQ increase in revenue. The rest of the income statement falls out from that. The consensus seems not to have expected anything like this rise, even though my cursory look at past years suggest that 4Q is usually stronger than 3Q. The stock has doubled since the report.

This is a spectacular case of operating leverage causing an immense positive earnings surprise. Most instances are nothing as explosive. But this is the general idea.

More tomorrow.