Valuation, 7th Edition

9Growth

Growth and its pursuit grip the business world. The popular view is that a company must grow to survive and prosper. There is certainly some truth to this. Slow-growing companies present fewer interesting opportunities for managers and so may have difficulty attracting and retaining talent. They are also much more likely to be acquired than faster-growing firms. Over the past 25 years, most of the companies that have disappeared from the S&P 500 index were acquired by larger companies or went private.

However, as discussed in Chapters 2 and 3, growth creates value only when a company’s new customers, projects, or acquisitions generate returns on invested capital (ROIC) greater than its cost of capital. And as companies grow larger and their industries become ever more competitive, finding good, high-value-creating projects becomes increasingly difficult. Striking the right balance between growth and return on invested capital is critically important to value creation. Our research shows that for companies with a high ROIC, shareholder returns are affected more by an increase in revenues than an increase in ROIC.¹ Indeed, we have found that if such companies let their ROIC drop a bit (though not too much) to achieve higher growth, their returns to shareholders are higher than for companies that maintain or improve their high ROIC but grow more slowly. Conversely, for companies with a low ROIC, increasing it will create more value than growing the company will.

The previous ...