REVENUE AND EARNINGS GROWTH: A GOOD THING?
Sure, companies prioritize growth in revenue and earnings. But there are times aggressive policies won’t benefit its shareholders. Firms tend to allocate huge amounts in risky or mature companies that can advance growth. But not all such ambitions are feasible and sustainable.
Is growth always a good thing?
As an investor, you are attracted to the idea of growth. And to bolster your portfolio, you invest in growth stocks because, hoping the companies can take shareholder money and reinvest it for a higher return. Investment expert Peter Lynch, in his book "One Up on Wall Street", he stated stock prices trail corporate earnings over time.
There is still a debate regarding this notion. California State University professor Cyrus Ramezani, in a 2002 study of over 2,000 public corporations, looked into the relation between growth and shareholder value. Based on his research, firms with the fastest revenue growth, with an average 167% annual sales growth over a 10-year period, reflected worse share price performance that slower growing corporations, with 26% average growth. Hence, there is no guarantee hotshot companies could retain their growth rates as they experience stock decline.
Growth is good, but too much can be detrimental, especially if the entity can no longer keep up with its expansion, hire and train employees, fulfill orders, and reach sales goals. If a company intends to boost expansion, it will be difficult to secure cash needs from operations. As a result, it can deplete money for years before attaining a positive cash flow.
Should that happen, it will spell trouble to the company and their investors. In the long run, every fast-growth industry becomes a slow-growth industry. But certain corporations still aim expansion even after opportunities have dwindled. Some of them even dismiss the option of offering investor dividends and continue to allocate earnings into expansions.
Chief executives and managers have the responsibility to halt growth if it won’t be sustainable or generate value. However, majority of company heads prioritize establishing empires over maintaining those. And compensation is linked to growth in revenue and earnings. Conversely, the financial industry favors growth, specifically a stock’s capacity to expand. Market analysts award the highest rating to shares with accelerating expansion. Not to mention tax rules uphold growth, as capital gains have lower tax rates, while dividends incur higher income tax rates.
Corporations, in order to lift growth rates, attempt to close huge, risky deals. So investors, when looking into a firm’s growth gameplans, consider its sustainability thoroughly. Remember, growth is not always a good thing, especially if the policies will render higher drawbacks than benefits.
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