Real Growth

Real Growth is the measure of a company's or an economy's growth after accounting for the effects of inflation. It strips away the price increases that can make growth figures look more impressive than they actually are, revealing the true, underlying increase in the volume of goods or services produced. Imagine a bakery that sold 100 loaves of bread for €1 each last year (€100 in revenue) and sells 105 loaves for €1.10 each this year (€115.50 in revenue). The nominal revenue growth is a healthy 15.5%. However, if the price of flour, yeast, and energy (inflation) rose by 10%, the bakery isn't 15.5% better off. The real growth in the number of loaves sold is just 5%. For investors, particularly those practicing value investing, understanding real growth is crucial. It helps you see which companies are genuinely expanding and creating value, rather than just riding a wave of rising prices.

For a value investor, the goal isn't just to find companies that are growing, but to find companies whose growth is real and sustainable. Nominal Growth figures can be a smokescreen, hiding underlying weakness.

Inflation is like a sneaky thief, quietly eroding the purchasing power of money. A company might boast about a 10% increase in revenue, which sounds fantastic. But if the general inflation rate for that year was 8%, the company's real growth is a much more modest 2%. This means that of the 10% growth, 8 percentage points were just keeping up with rising prices, and only 2 percentage points represented a genuine increase in business activity. A company that can't grow faster than inflation is essentially running on a treadmill—it's working hard but not actually moving forward. A true value creator consistently posts positive real growth.

This concept applies directly to your investment returns. Your portfolio might have grown by 12% in a year. Congratulations! But if inflation was 7%, your real return—the actual increase in your spending power—is only 5%. This is the number that truly matters for reaching your long-term financial goals, like a comfortable retirement. Focusing on real growth helps you set realistic expectations and make smarter decisions about where to invest your hard-earned money.

The good news is that you don't need a PhD in economics to figure this out. The math is straightforward.

The basic formula to find the real growth rate is: Real Growth Rate = Nominal Growth Rate - Inflation Rate For example, if a company's EPS grew from $5.00 to $5.50, its nominal growth is 10% (($5.50 / $5.00) - 1). If the CPI, a common measure of inflation, rose by 3% over the same period, the real EPS growth is: 10% (Nominal Growth) - 3% (Inflation) = 7% (Real Growth) This 7% figure gives you a much clearer picture of the company's performance.

Getting the numbers for this calculation is relatively easy:

• Nominal Growth: You can find this in a company's financial statements (income statement, balance sheet). Look at the year-over-year growth in key metrics like revenue, earnings, or book value.
• Inflation Rate: This data is published by government agencies. In the United States, the Bureau of Labor Statistics releases the CPI. In Europe, Eurostat publishes the Harmonised Index of Consumer Prices (HICP).

While the basic formula is a powerful tool, a savvy investor knows to dig a little deeper.

• Different Kinds of Inflation: The CPI measures consumer price inflation, but a company might be more affected by producer prices. The PPI measures inflation for raw materials and other inputs businesses buy. For an industrial company, real growth calculated using the PPI might be more revealing.
• Industry-Specific Costs: A great value investor will consider inflation specific to a company's industry. For example, if you are analyzing an airline, the price of jet fuel is a massive factor. A general inflation rate of 2% is meaningless if fuel costs have soared by 20%. True analysis means looking at how a company's specific costs have changed relative to the prices it can charge its customers. This is where you find the hidden gems—companies with strong pricing power that can outrun their specific cost inflation.