What to look for: Growth

Important attributes to look for in an earnings statement - GROWTH

After all is said and done, the long-term growth of a stock price is driven by growth in the business.

Growth in the business means growth in the earnings - there is no other way to sustain business growth without infusions of additional owner capital.

Sure, you can acquire, merge, or sell more stocks to make a business larger by common definitions, but has the business really "grown"?

The value investor works to obtain a deep understanding of business growth, growth trends, and the quality of growth.

• Is reported growth based on internal core competencies?
• Or is it acquired or speculative growth based on unproven ventures?

The value investor assesses growth and growth patterns, judges the validity of growth reported, and attempts to project the future.

A business' ability to grow on its own, through its own success and resulting earnings, is known as organic growth.

Growth through acquisition or other capital infusions are not "organic" and thus does not suggest growth in true business value.

Ensuring that successful growth continues or is rekindled

All growth efforts eventually slow. But neither your business nor your career has to decline in tandem with them as long as you stay alert to the dynamics that are in play and cultivate the ability to adapt.

These steps can help ensure that successful growth continues, or is rekindled:

1. Review current business activities: this may involve analysing strengths, weaknesses, opportunities, and threats (SWOT), as well as assessing the business's relative market share.

Answer the following questions:

• Where are the most profitable parts of the business?
• What are the prospects in the short-, medium-, and long-term for those products and markets?
• How precarious is the business - for example, does it rely on too few products, customers, or distribution channels?
• How clearly focused is the business - is it over-burdened with too many products, markets, and initiatives, or is it running on empty with too few opportunities?
• What is likely to be the best method of expansion - is it affordable (not just in terms of money)?
• What are the advantages and disadvantages of expanding?

2 Decide the best method of achieving growth: discuss the options with senior managers and shareholders, refining potential opportunities and deciding how to approach problems.

3. Plan for growth: decide what action is needed to achieve growth. This will involve leadership qualities to communicate and mobilise resources.

4. Act decisively and consistently: once the course has been set it needs to be rigorously followed. One of the greatest obstacles to growth is inertia, often in the form of attachment to heritage and past activities. However, Sir John Harvey Jones, one of the UK's most successful businessmen, emphasised the point that any business is only as good as its next three months' order book.

• Pay attention to the details of any strategy for growth. Understand how the changes affect people.
• Decisive action is vital, but this needs to include an understanding of how to maintain people's commitment and motivation. If people feel threatened, or insecure, then however sensible the strategy for growth and the plan for implementation it simply will not be achieved.
• It is vital to treat people with respect. It is also worth communicating what is happening to people so that they understand their role and how they can contribute.
• Also, monitor the situation; time lags need to be understood and planned for, and the strategy needs to be supported in the long term.

Taking Growth for Granted

Growth can never be taken for granted. There is no such thing as a growth industry - growth is a matter of being perceptive enough to spot where future growth may lie.

History is filled with companies that fall undetected into decay because:

• they assume that the growth in their particular market will continue for as long as the population grows in size and wealth
  
• they believe that a product cannot be surpassed
  
• they tend to put faith in the ability of improved production techniques to deliver lower costs and, therefore, higher profits.

Bad Growth

Bad Growth

Bad growth is not confined to mergers and acquisitions lacking strategic rationale. Price-cutting to gain market share without a corresponding decrease in costs can also lead to disaster.

Some businesses are capital intensive with high fixed costs and a high breakeven point, for example, the building-materials industry. Cutting prices to gain significant market share maybe successful at least initially. However, the competition had no choice but to respond in kind, since a loss of market share in this high-fixed-cost industry means a loss of both cash flow and profitability. The end result of all that price cutting caused industry revenue and profits to shrink, which obviously, affected every business in the same industry. It may take some time to restore equilibrium to the business.

Cost cutting could have been succesful to gain market share if the company had improved productivity and offered higher-quality products and creating a better cost structure, ahead of the competition. With lower costs and higher-quality products, it would have been possible to cut prices and build market share while maintaining margin. Another approach could have tried to search out the most profitable segments of the market and/or become the industry's innovator.

With no intrinsic competitive advantages, the only result of price cutting was that everyone in the industry suffered, not without its consequences to the managers and management too.

Buying growth through uneconomic price discounting

Gaining market share by giving some customers unusually favourable credit terms - terms that result in your losing money on every sale - is another example of bad growth. It never works long term.

Subsidizing buyers' purchases of your product by charging them little or no interest on the financing options you offer them, or by giving them an extended period until they have to pay you, may spike sales in the short term, but it is never effective as a long-term growth strategy.

In these situations, companies are able to record revenues and profits in accounting terms, and managers get their bonuses for meeting targets, but at the end of the day a cash crisis arises and huge write-offs ensue.

How to Tell Good Growth from Bad Growth

How to Tell Good Growth from Bad Growth

All top-line growth is not created equal. History has shown that most mergers and acquisitions do little to help the long-term health and revenue growth of an organization. Growth that uses capital inefficiently is not the way to go.

How can you tell good growth from bad?

How good growth builds value

Growth of any kind increases revenues. Good growth not only increases revenues but correspondingly improves profits and is sustainable over time. It is primarily organic (internally) generated from the ongoing operations and business of the company and is based on differentiated products and services that meet new or previously unmet consumer needs.

Good growth is thus growth that is profitable, organic, differentiated, and sustainable (PODS). Good growth builds shareholder value over time. In contrast, bad growth destroys shareholder value.

Mergers and acquisitions, a primary example of bad growth, are often based on myopic visions of synergy that have no basis in the reality fo the market place. Instead of 4 plus 4 equaling 10, as promised when the deals are announced, more often than not 4 plus 4 winds up equaling 5 or 6. It is true that a large number of mergers and mega-acquisitions result in one-shot cost synergies - usually cost savings from the elimination of duplication with the merged enterprise - but seldom in an improved rate of revenue growth that is sustainable for the long run.

Compared with growing through a string of major acquisitions, good growth offers better returns over time, is less risky, and saves companies from crippling high debt and cash crises such as those faced by Vivendi and AOL Time Warner.

Vivendi acquired (among other things) Universal Studios, Blizzard Entertainment, and Def Jam. The problem? Vivendi overpaid and used debt to pay for most of those high-priced acquisitions. While the companies it bought were making money, Vivendi as a whole plunged into the red, after taking into account the repayment of interest on the billions of dollars it borrowed. The financial condition of the company became so acute that many wondered if it would survive.

Of course, not all acquisitions are bad. There are times when scale (i.e., your overall size in relation to competitors) matters and it can be impossible to compete against industry giants without it.

Phillips and Conoco were both relatively small fish in the energy market. They were both growing but they were at a huge competitive disadvantage versus ExxonMobil or BP. The Conoco-Phillips merger in 2002 (the new company is called ConocoPhillips) took out costs, and the integration of the two companies has been extremely successful. They have built on each other's strengths.

Similarly, there are times when an industry goes through a consolidation wave. At those moments, you either get bigger or find yourself at a disadvantage.

But, overall, organic growth remains the way to go. It results in a better price-earnings ratio so that when an industry undergoes consolidation, this strength provides a company with the upper hand in making appropriate acquisitions against its competition. The end result is a company with additional scale and scope and greater credibility to go to the next level.

The Stages Of Industry Growth

The Stages Of Industry Growth
by Jason Van Bergen (Contact Author Biography)

It is no accident that companies within a particular industry move in lock-step with one another. Companies in a single industry are forever bound by the type of product or service that they provide, and they are constantly competing with one another for market share, consumer acceptance, as well as technological leadership in their particular sub-sector. These competitive and consumer forces shape an industry's corporations and determine the status of the industry as a whole. These forces have followed roughly the same patterns over time, providing a very clean model for the of an industry, the various stages of growth (and decline) experienced by its companies. Here we take a look at these stages and how they determine what kind of investments these companies are.


Initial Growth / Emerging Industries

All companies have to start their business somewhere, and it takes only a single company or small group of companies to jumpstart an entire industry. Looking back in time, we see that it was not even a company but an individual by the name of Alexander Graham Bell who, with the invention of the telephone, started the entire industry of telecommunications. More recently, companies like Texas Instruments and Fairchild Semiconductor Corporation pioneered the semiconductor industry with the invention of the microchip, the central component of all computers and most high-tech electronics gear. Companies involved in establishing emerging industries are generally participating in perilous business, as their primary concerns are raising sufficient funds to engage in early-stage research and development. In their developmental stages, which may last months or even years, these companies are likely operating on a shoestring budget, while at the same time presenting to the world a product or service that is yet to be accepted. These pioneering companies might face bankruptcy, development failure and poor consumer acceptance. Companies in emerging industries are typically recommended to investors with a very high risk tolerance. An adage often used in relation to an initial growth investment is "If you cannot afford to lose your investment in this company, do not make the investment in the first place!" Individual investors are likely to have access to initial growth companies through private investments, sometimes called "friends-and-family capital". At such an early stage, investors often know the company founders personally. And they can only hope to make a profit on their investment in the distant future, when the company offers its shares on a secondary trading market, or when the investor can find somebody else to purchase his or her ownership at a premium (which would take place, for example, if another company were to purchase all of the outstanding shares of the company). Companies in emerging industries are occasionally quoted on major stock exchanges or traded over the counter, and should always be considered in terms of the significant risk they pose. These companies will often be unprofitable, and the large initial start-up costs may result in ongoing negative cash flows. As such, traditional fundamental analysis is often not applicable in emerging industries, and investors must be sophisticated enough to learn or even develop entirely different means of analyzing these stocks. Investing in emerging industries is not for the faint of heart.

Rapid Growth Industries

Companies in industries that are benefiting from rapid growth have sales and earnings that are expanding at a faster rate than firms in other industries. As such, these companies should display an above average rate of earnings on invested capital for an extended period of time, probably years. Prospects for rapid growth companies should also appear bright for continued sales and earnings growth in ensuing years. During this period of rapid growth, companies will eventually begin to lower prices in response to competitive pressures and the decline of costs of production, which is often referred to as economies of scale. But costs decrease at a higher rate than prices, so companies entrenched in growth industries often experience growth in profits as their product or service becomes fully accepted in the marketplace. The consumer electronics industry, for example, is characterized by much research and development, followed by significant economies of scale in production. Prices in home electronics inevitably fall, but the costs of production fall faster, thereby ensuring increasing profitability. Publicly traded companies involved in rapid growth industries, often referred to as growth stocks, are some of the most potentially lucrative investments due to their ability to sustain growth in revenues and profits over long periods of time. Microsoft is an excellent example of a company that became very large in a growth industry (software) over a period of years, increasing its earnings all the while and, most importantly, maintaining its expectations for continued future growth.

Mature Industries

Once an industry has exhausted its period of rapid growth in revenues and earnings, it moves into maturity. Growth in the companies in mature industries closely resembles the overall rate of growth of the economy (the GDP). Earnings and cash flow are still likely positive for these companies, but their products and services have become less distinguishable from those of their competitors. Price competition becomes more vicious, taking profit margins along with it, and companies begin to explore other areas for products or services with potentially higher margins. Many of our economy’s most closely watched industries, such as airlines, insurance and utilities can be categorized as mature industries. Despite their rather staid position in mature industries, investments in these companies' stock can remain very attractive for many years. Share prices within mature industries tend to grow at a relatively stable rate that can often be predicted with some degree of accuracy based on sustainable growth prospects from historical trends. Perhaps even more importantly, companies in mature industries are able to withstand economic downturns and recessions better than growth companies, thanks to their strong financial resources. In troubled times, mature companies can draw from retained earnings for sustenance, and even concentrate on product development in order to capitalize on the economy’s eventual return to growth. Investors in mature industries are those who want to enjoy the potential for growth but also avoid extreme highs and lows.

Declining Industries

Industries that are unable to match even the basic barometer of economic growth are in a stage of decline. Some factors that could contribute to a declining industry are consumers decreasing their demand for the industry’s product or service, technology that supplants legacy products with new and better ones, or companies in the industry failing to be competitive in pricing. An industry that exemplifies all the tendencies of a declining market is the railroad industry, which has experienced decreased demand - largely due to newer and faster means of transporting goods (primarily air transport) - and has failed to remain competitive in pricing, at least in relation to the benefits of faster and more efficient transportation provided by airlines and trucking services. We should note that declining industries may experience periods of stable or even increasing growth from time to time, even if their overall prospects are on the way down. For example, railroad transport is still very much an active industry sector, as the non-competitive firms have been weeded out. Declining industries tend to be poor places to seek investment opportunities, although individual companies within these industries may still have investment merit. Even in the industries where prospects look bleakest, there are always companies that are able to buck the trend and generate growing revenues and profits while those around them falter. But investors who are not inclined to search for such companies are better advised to look for investments in industries that are in the younger stages.

Conclusion

Classifying industries according to their stage of growth can be extremely useful for the purposes of finding companies that match your investment objectives. Have a look at a graph above outlining the stages we discussed:

Conservative-minded investors who are looking for a bit of stability in the equity portion of their portfolios will first want to check out mature industries, where there is the best selection of blue-chip stocks that are widely traded, having extreme trading liquidity.

Investors with a taste for risk may want to take advantage of the higher potential for return that growth industries can provide.

And investors who like to live their lives on the razor edge between success and failure may consider investments in emerging industries, even though such investments tend to be geared toward private companies.

The only constant when it comes to considering investments in various industries is that it may be best to avoid industries in decline.

by Jason Van Bergen, (Contact Author Biography)

http://www.investopedia.com/articles/basics/04/030504.asp?partner=TOD5

Profitable Growth

Good growth has to be not only profitable but capital-efficient - that is, it needs to earn a return on its investment greater than the company could have received by putting its money in something ultra-safe, such as a Treasury bill. Colgate-Palmolive's growth is definitely profitable.



For more than a decade, Colgate has been on a sustained march to becoming number one in the oral-care consumer-products market, and, as mentioned, has edged out both Procter & Gamble and Unilever. As important as its growth in revenues has been Colgate's steady improvement in profitability. Its gross margin has increased from 39% in 1984 to close to 60% in 2003, an improvement of almost one point per year.



Gross margin - your revenue less what it costs to make the product to obtain those revenues - is an important indicator of a company's profitability and often not given the due it deserves. Increasing gross margin and at the same time growing revenues at a rate better than the overall market is what makes for a great growth company. It is here that you can directly see the relationship between improved productivity and profitable growth. Colgate for more than a decade has been able to find ways to consistently enhance its competitive position by making its operations more productive and streamlining its processes.

The improvement of Colgate's gross margin also reflects its ability to innovate ahead of its two chief competitors. Colgate has created a corporate "growth group" with two major responsibilities.

1. The first is to be continuously focused on developing new products, extending existing products, and improving packaging.


2. The second, equally important, job is to concentrate on logistic, production, delivery, and speed and responsiveness to retailers through the effective use of data warehousing, information technology, and cost productivity.

Again, it is an example of a top company recognizing that it must simultaneously improve productivity costs and grow.



Both processes resulted in Colgate's winning shelf space. It also meant lowering costs not only for Colgate but for retailers as well. Colgate reduced what it cost retailers to stock and sell its products while increasing retailers' inventory turns of Colgate products, thereby reducing the retailers' cost.



Colgate grew and grew more profitably than the competition, despite the huge lead that Procter & Gamble and Unilever had at the beginning of the race. It did so by continually focusing on the core business and findinng ways to make it better. It emphasized "singles and doubles." Colgate obsessed about what was happening to its brands in each retail outlet, focused on :

• the needs of retailers,


• created consumer awareness,


• continued to improve its products, and


• persuaded the consumer to prefer its products.

The growth path that Colgate chose has been good for shareholders and employees. The company's rapid growth has allowed it to attract the best managers in the industry - managers who are committed to growth.

****Seek good growth and avoid bad growth

I love to invest in good quality long-term profitable growth businesses available at reasonable or bargain prices. Yet, growth can be good and can also be bad. Let's take a look.

A framework for distinguishing good from bad growth is a crucial element in generating revenue growth.

Good growth:

• not only increases revenues but improves profits,
• is sustainable over time, and
• does not use unacceptable levels of capital.
• is also primarily organic (internally generated) and
• based on differentiated products and services that fill new or unmet needs, creating value for customers.

The ability to generate internal growth separates leaders who build their businesses on a solid foundation of long-term profitable growth from those who, through acquisitions and financial engineering, increase revenues like crazy but who create that growth on shaky footings that ultimately crumble.

Many acquisitions provide a one-shot improvement, as duplicative costs are removed from the combined companies. But few, if any, demonstrate any significant improvement in the RATE of growth of revenues.

Estimating Growth in Value Investing

Estimating Growth in Value Investing
Avoid using valuation based on growth estimates

Another reason for pure value investing’s aversion to valuation based on growth estimates is that growth’s potential value can be ascertained using other accounting tools not requiring estimates.

This involves comparing valuation estimates using earnings with those using assets.

Three possibilities arise: The valuations are the same or one or the other is higher.

1. Earnings value = Asset value
When they are the same, growth bears no value as just noted.

2. Asset value > Earnings value
When asset value exceeds earnings value, managers are deploying assets sub-optimally, either due to ineptitude or excess industry capacity. No value resides there.

3. Earnings value > Asset value
When earnings value exceeds asset value, it is due to competitive advantages or barriers to entry, and these clues indicate potential value in growth. This indicates a company possessing franchise value. One measure of that value is the excess of earnings value over asset value. It is captured in the expression return on equity. This economic goodwill makes companies value investor candidates.


Also read:

1. Income Statement Value: The Earnings Payoff
2. Adjustments in Current Earnings figure
3. Avoid Pro Forma financial figures
4. Avoid Extrapolated Future Earnings Growth figures
5. Estimating Growth in Value Investing
6. Franchise Value
7. GROWTH'S VALUE
8. GROWTH'S VALUE (illustrations)

Value? Growth? Both!

Value? Growth? Both!
By Julie Clarenbach January 2, 2009 Comments (0)
http://www.fool.com/investing/general/2009/01/02/value-growth-both.aspx?source=ihptclhpa0000001

The same company can be both a growth and a value stock. Value investing, after all, wants to buy companies selling at a discount to their intrinsic value. Growth investing wants to buy companies that will grow their bottom lines -- and presumably your investment -- many times over. But there's nothing excluding fast-growing stocks from being undervalued. That's why Warren Buffett himself said that "growth and value investing are joined at the hip."

Putting the puzzle together The other piece that gets lost in the "value vs. growth" debate is this: You shouldn't be buying only one stock anyway. You should be building a portfolio. And that portfolio should be -- say it with me now -- diversified.

One premise of diversification is that different kinds of stocks do better in different market environments. Putting together assets that don't move in the same direction at the same time will create the best chance for high returns with lower overall volatility. Notice how each of these different investment classes go into and out of fashion at different times:

Large Caps
Small Caps
International
REITs

So when you're picking stocks, make sure you choose from a variety of categories:

• Large-cap stocks, being more established, typically endure less volatility; small-cap stocks, on the other hand, are more risky but also have the potential to be more rewarding.
  
• Value stocks provide downside protection and a reasonable assumption of an upside, while growth stocks take advantage of room to double, triple, and quadruple in value.
  
• Domestic stocks take advantage of the unparalleled power of American industry -- but emerging economies, which don't always move in lockstep with developed economies, have room to grow much faster than ours.
  
• While they have may have a reputation for being slow growers, dividend payers have historically boosted performance for investors: From 1960 to 2005, about 80% of the market's returns came from reinvested dividends.
  
• Diversifying across industries ensures that your portfolio isn't wiped out from unforeseen economic, political, or natural disasters. While the credit crisis bankrupted numerous financials and pushed department store stocks down an average of 64% in 2008, discount stores, biotech, and waste management have held their own.

Your portfolio should have all of these: large caps and small, value stocks and growth, domestic stocks and international, as well as some dividend payers -- all from a variety of industries.

Whoa -- how many stocks are we talking here? It won't necessarily take dozens of stocks to diversify in all of these ways, because, as I mentioned earlier, the same stock can fit into multiple categories.

Take "technology, media, and financial services company" General Electric (NYSE: GE) as an example. Where would it fit on this list? It has a market cap of $170 billion, Morningstar considers it a value stock, it currently yields 7.9%, and while it's based in Connecticut, half of its revenue comes from outside the United States.
Or what about tiny China Fire & Security (Nasdaq: CFSG)? It's a $190 million growth company selling fire-protection products to Chinese corporations.
Every single stock you consider is going to fit many different categories, and thus will diversify your portfolio in multiple ways. The key is to fit your holdings together to achieve meaningful diversification, so that you can enjoy strong returns with minimal risk.

The Foolish bottom line

As important as diversification is, it's secondary to buying stocks worth holding for the long run.

But as you consider the world of stocks worth holding, you want to make sure you're blending them together for a portfolio that can earn you great returns while weathering all kinds of markets.

Growth

There is a huge difference between the business that grows and requires lots of capital to do so and the business that grows and doesn’t require capital. (Warren Buffett, 1994 Berkshire AGM)



Growth


When a company is said to be “growing its business” or simply “growing”, it means that the business is using its retained profits or new capital to expand its existing business or to acquire other ready-made businesses.




Organic growth: Growth is said to be organic when a company is using retained profits and debt to expand its existing operations.

The ability to increase market share or penetrate new markets without compromising profit margins indicates a healthy demand for the company’s products or services. Such businesses therefore normally make good long-term investments.




Growth by acquiring other businesses: Companies with limited potential to expand organically might grow externally by acquiring other businesses using existing resources or new capital.


If profitability or ROFE (return on funds employed) from a new acquisition is less than the ROFE in the existing business, the decline in overall profitability will reduce the per-share value.


Because capital-allocation decisions are the Achilles heel of most businesses, companies on the acquisition trail should be treated with caution.



Acquisitions that come at a price that is hard for seller to refuse, while increasing profit in absolute terms, frequently lead to diminished profitability and therefore loss of per-share value.