Many factors can derail any business forecast.

Forecasting future growth is considerably imprecise

Forecasting sales or profits many years into the future is considerably more imprecise, and a great many factors can derail any business forecast. 

There are many investors who make decisions solely on the basis of their own forecasts of future growth. After all, the faster the earnings or cash flow of a business is growing, the greater that business’s present value. 

Difficulties confronting growth-oriented investors

Yet several difficulties confront growth-oriented investors. 

• First, such investors frequently demonstrate higher confidence in their ability to predict the future than is warranted. 
• Second, for fast-growing businesses even small differences in one’s estimate of annual growth rates can have a tremendous impact on valuation.  
• Moreover, with so many investors attempting to buy stock in growth companies, the prices of the consensus choices may reach levels unsupported by fundamentals. 
• Investors may at times be lured into making overly optimistic projections based on temporarily robust results, thereby causing them to overpay for mediocre businesses. 
• When growth is anticipated and therefore already discounted in securities prices, shortfalls will disappoint investors and result in share price declines.

When a good business can become a bad investment

 As Warren Buffett has said, “For the investor, a too-high purchase price for the stock of an excellent company can undo the effects of a subsequent decade of favorable business developments.” 

Growth investors tend to oversimplify growth into a single number

Another difficulty with investing based on growth is that while investors tend to oversimplify growth into a single number, growth is, in fact, comprised of numerous moving parts which vary in their predictability. 

Sources of earnings growth

For any particular business, for example, earnings growth can stem from increased unit sales related 

• to predictable increases in the general population, 
• to increased usage of a product by consumers, 
• to increased market share, 
• to greater penetration of a product into the population, or 
• to price increases. 

Specifically, a brewer might expect to sell more beer as the drinking-age population grows but would aspire to selling more beer per capita as well. Budweiser would hope to increase market share relative to Miller. The brewing industry might wish to convert whiskey drinkers into beer drinkers or reach the abstemious segment of the population with a brand of nonalcoholic beer. Over time companies would seek to increase price to the extent that it would be expected to result in increased profits. 

Some of these sources of earnings growth are more predictable than others. 

• Growth tied to population increases is considerably more certain than growth stemming from changes in consumer behavior, such as the conversion of whiskey drinkers to beer. 
• The reaction of customers to price increases is always uncertain. 

On the whole it is far easier to identify the possible sources of growth for a business than to forecast how much growth will actually materialize and how it will affect profits. 

Confine your study to companies with good sales or earnings growth.

Don't bother to continue with a stock study if sales or earnings growth is inadequate.

Sales growth is inadequate if it is below the guidelines for the size of the company you are studying (ranging from around 7 percent for a large company to 12 percent for a smaller one).

Earnings growth should be around 15 percent or better; but you can accept slower growth from companies whose dividends contribute substantially to the total return.

How Value Investor identifies Earnings, Sales and Future Growth

The real goal of the value investor is to identify companies with solid financial base that are growing at a faster rate (in terms of sales and earnings) than both their competitors and the economy in general.

All things being equal, share price is likely to increase in value at about the same rate that sales grow.

For dominant companies in major industries, an investor will want a sales growth rate of 5 to 7 percent.  

Within a portfolio, look for an overall sales growth rate of at least 10% annually.

Earnings need not rise every year. Almost all industries operate in cycles, and any company can suffer a temporary setback.

But investors should be wary

• when a company's earnings and sales are erratic without explanation or 
• when sales and earnings are slowly sinking and the company is not taking corrective action.

Speculative-Growth Stocks - What's the Growth Trend?

Rapid sales growth won't do us any good if it can't be sustained.

We want staying power, not sales growth of 50% one year and shrinkage the next.

Even though it has only been around for a few years, Yahoo has been one of the most consistent Internet stocks around, growing steadily without a lot of wild swings from quarter to quarter.  

• The pace of that growth has been steadily declining (from 230% in 1997 to 120% in the first quarter of 2000), but that's to be expected as a company gets bigger and grows from a larger base.  
• Yahoo has demonstrated a lot of staying power, at least by the standards of Internet stocks.

All revenue growth starts with an idea.

All revenue growth starts with an idea. The idea could be for a new product or a new service. Or it can be an addition to a product or a service that already exists. Or it can be an idea that begins as almost idle speculation - "I wonder what would happen if...."

Employees, from the rawest recruits to crusty veterans of the business, have ideas, and many of them have the potential to help the enterprise. The leadership challenge is to have a social process that helps draw them out. After all, those ideas don't do your company any good if people won't voice them.

The social engine can help, of course. The interactions among the various departments - marketing and R&D, for example, or customer services and sales - will spark more ideas worth pursuing.

Your organization doesn't need to wait for the proverbial light-bulb to go on in order to come up with new ideas. Innovation can be operationalized. You can develop a process that you can follow to surface ideas and then, develop as many growth ideas as possible.

Unlike cost-cutting, growing revenues requires innovation. Many people think only geniuses can innovate. And, indeed, genius is always welcom. However, innovation is a social process and everyone can participate. Once the process is firmly integrated into the way the company does business every day, you will find more and more geniuses coming out of the woodwork.

Silicon Valley is filled with geniuses. But if you look at the successful entrepreneurs who work there, you will discover a curious thing. The vast majority of them worked - often for a long time - at established firms before going off on their own. Part of the attraction, of course, in starting their own companies was the freedom and equity ownership that come along as part of the deal. But another reason for leaving had to do with the fact that their old companies just could not accommodate them and what they wanted to do. Had their former employers handled the social innovation process better, a certain percentage of those entrepreneurs would have stayed and probably contributed in a big way to the growth of their former company.

How can you turn innovation into profitable growth?