Growth Rate

The Growth Rate is a simple but powerful concept that measures the percentage change in a specific variable over a set period. In the world of investing, we're typically talking about how fast a company's revenues, earnings, or dividends are expanding (or shrinking!). Think of it as the company's financial speedometer. A positive growth rate means the company is getting bigger, while a negative one signals it's contracting. For a value investor, understanding the nature and pace of a company's growth is not just a side-note; it's a fundamental piece of the puzzle for determining what a business is truly worth. While often associated with the high-flying world of “growth stocks,” legendary investors like Warren Buffett have made it clear that growth is an inseparable component of the value equation.

At its core, a business is a machine for generating cash. A business that can grow its ability to generate cash over time becomes more valuable. The growth rate is our best tool for measuring this progress.

A common misconception is that value investors only hunt for cheap, slow-moving, cigar-butt-style companies. Not so! A key part of calculating a company's Intrinsic Value—what it's really worth—is forecasting its future earnings. This is impossible without estimating its growth rate. In a Discounted Cash Flow (DCF) analysis, for instance, the growth rate of future cash flows is one of the most sensitive and important inputs. However, a true value investor doesn't just look at a high growth number and get excited. The crucial questions are:

• Is this growth profitable?
• Is it sustainable?
• How is the company paying for this growth? Is it using its own cash, or is it piling on debt or diluting shareholders?

Quality, sustainable growth creates value; reckless, unprofitable growth destroys it.

The basic formula is wonderfully straightforward: ( (Current Value - Past Value) / Past Value ) x 100% For example, if ACME Corp.'s Earnings Per Share (EPS) was $2.00 last year and is $2.50 this year, its annual EPS growth rate is: ( ($2.50 - $2.00) / $2.00 ) x 100% = 25% For periods longer than a year, it's better to use the Compound Annual Growth Rate (CAGR). CAGR calculates the average annual growth rate over a specified period, smoothing out the lumpy, volatile results you might see year-to-year. It provides a much more realistic picture of a company's growth trajectory.

Investors track the growth of several key metrics to get a holistic view of a company's health.

This is the “top-line” growth. It tells you if the company is selling more of its products or services. Strong revenue growth can signal increasing market share and healthy demand. However, it's only half the story. A company can grow revenues by aggressively discounting its products, which can crush its profitability.

This is the “bottom-line” growth, looking at metrics like Net Income or EPS. This is often considered the holy grail because it shows that the company's growth is profitable. It's the money that ultimately belongs to the shareholders. Always dig deeper to understand the source of earnings growth—is it from selling more widgets efficiently, or from one-time events, accounting tricks, or aggressive share buybacks?

For investors focused on generating an income stream, the rate of dividend growth is paramount. A company with a long history of consistently increasing its dividends signals financial strength, stability, and a shareholder-friendly management team. This is the bedrock of the Dividend Growth Investing strategy.

Chasing growth without discipline is one of the fastest ways to lose money in the stock market.

This is a classic mistake. The market gets so excited about a fast-growing company that it bids the stock price up to astronomical levels. These prices often bake in heroic assumptions about future growth. The moment that growth shows any sign of slowing—which it inevitably does—the stock can collapse as expectations meet reality. Overpaying for growth, no matter how exciting, violates the core principle of investing with a Margin of Safety.

Remember, not all growth is created equal.

• Good Growth: Is funded by the company's own profits (Retained Earnings) and generates a high Return on Invested Capital (ROIC). This is self-sustaining and creates immense value.
• Bad Growth: Is funded by taking on huge amounts of debt or by constantly issuing new shares, which results in Share Dilution. This “growth” can actually make existing shareholders poorer.

It is mathematically harder for a giant company to grow quickly. A small, $10 million company can realistically double its revenue to $20 million in a year. For a titan like Amazon or Microsoft, doubling revenue would mean finding hundreds of billions in new sales, a far more difficult task. As you analyze a company, you must assume its growth rate will naturally slow as it matures and gets bigger.

• Growth is a Component of Value: Don't think of “growth” and “value” as opposing forces. Growth is a key variable in the valuation equation.
• Investigate the Source: Always ask how a company is growing. Is it through operational excellence or financial engineering?
• Don't Overpay: Be deeply skeptical of extrapolating high growth rates far into the future. The fastest way to get hurt is to pay a high price for a rosy scenario that never materializes.
• Use CAGR: When looking at history, use the Compound Annual Growth Rate to get a smoother, more representative picture of performance over time.