Revenue and earnings growth

In simple terms

Growth is the number investors care most about, and the one most easily flattered. A company can make its growth look impressive by choosing a convenient starting year, by buying other companies, or by quoting growth in total profit while each shareholder's slice grows much more slowly.

Measuring growth properly means asking four questions: growth of what, over which period, from where, and per share or in total?

Year-on-year and multi-year growth

Year-on-year growth compares one year with the previous one:

It is useful but noisy. One good or bad year, a large order, a strike or a change in raw material prices can swing it widely.

Multi-year growth smooths this out. The compound annual growth rate (CAGR) gives the steady yearly rate that links a start value and an end value:

Choosing the period

Start and end points can change the answer dramatically. Growth measured from a slump looks fast; growth measured from a peak looks slow. This is the base effect, covered in the percentages lesson.

Good practice:

• Use several years, typically five to ten.
• Cover a full cycle for cyclical businesses, from one peak or trough to the next.
• Check sensitivity: calculate growth from a few different start years and see whether the story changes.
• Be wary of growth quoted from an unusual year, such as a year disrupted by a one-off event.

Revenue growth and profit growth

Compare the two. They tell different stories.

• Revenue growing faster than profit means margins are falling. The company may be cutting prices, facing rising costs, or spending heavily to grow.
• Profit growing faster than revenue means margins are rising. This can come from operating leverage, cost cuts or pricing power, but also from one-off gains or lower tax, which may not last.
• Profit growth with no revenue growth for several years usually cannot continue: costs can only be cut so far.

Over long periods, sustained profit growth needs revenue growth.

Organic and acquired growth

Organic growth comes from the existing business: selling more, selling at higher prices, entering new markets. Acquired growth comes from buying other companies and adding their revenue and profit.

Acquisitions can create value, but they are bought with cash, debt or new shares, so the growth is not free. A company growing 20% a year by acquiring others may have an existing business that is barely growing. Annual reports and results presentations often split growth into organic and acquired parts; if they do not, compare growth in years with and without acquisitions.

Growth per share

What matters to a shareholder is growth in their share of the profits: earnings per share (EPS). Total profit can grow while EPS grows much less, or even falls, if the company issues many new shares.

Why it matters

Valuations depend heavily on expected growth, so overestimating it is costly. A company that looks like a 25% grower because of a lucky start year, acquisitions or share issues may be a 5% grower underneath. Measuring growth carefully, over sensible periods and per share, is one of the simplest ways to avoid overpaying.

Limitations

Past growth is history. It tells you what a business has achieved, not what it will achieve; growth rates usually slow as companies get larger. Growth figures also depend on accounting: a change in how revenue is recognised, or a restatement, can change past figures. Read the notes for such changes.

Common mistakes

• Extrapolating one strong year. One year is not a trend.
• Measuring from a depressed base. Recoveries are not growth.
• Ignoring acquisitions. Bought growth costs money or shares.
• Ignoring dilution. Use EPS growth as well as total profit growth.
• Focusing on profit and ignoring revenue. Margin-driven growth has limits.

Try it yourself

Choose a listed company and collect ten years of revenue, net profit and EPS from its annual reports or the exchange website.

1. Calculate the ten-year and five-year CAGR of each.
2. Recalculate the five-year CAGR starting one year earlier and one year later. How much does it change?
3. Compare profit growth with EPS growth. Is there a gap?
4. Check the annual reports for acquisitions and note the years they happened.