Limits to (Revenue) Growth

Do businesses always have to grow?

Business life cycle. Source: Aswath Damodoran

The short answer of course is no. There’s lots of businesses that have falling revenues. In fact, one classic way to turn around an unprofitable enterprise is to shrink it to profitability. There’s a life-cycle to most companies and industries: start-up, growth, maturity, and decline. It’s happened in technology (PCs), newspapers, transportation (trains), and other areas. It may be happening to brick-and-mortar retailers today.

But we don’t like to think about shrinking businesses. It seems unnatural to assume that a firm will see diminishing sales and declining margins. We lionize Steve Jobs, not Larry the Liquidator. CEOs that grow their companies get put on a pedestal, with books written by and about them. Leaders that preside over mature corporations don’t get as much attention.

That’s what can make value investing so tricky. The fair market value of a company in decline is a lot lower than one that’s early in its life cycle. Declining firms distribute more cash to shareholders as well, because there are fewer opportunities to deploy it profitably within the company. Taken in aggregate, value stocks are cheaper—but often, they are cheap for a reason. Blindly purchasing low PE stocks and high dividend yields can lead to disappointment—a “value trap.”

In sports, defense is just as important as offense. But people like to score goals more than they like preventing them. This cognitive bias can create opportunities. Declining firms aren’t worthless. When irrational gloom sets in, investors can profit—if they’re careful. As always, valuation—and values—matter.

Douglas R. Tengdin, CFA

Chief Investment Officer

By | 2017-07-17T12:21:36+00:00 December 6th, 2016|Global Market Update|0 Comments

About the Author:

Mr. Tengdin is the Chief Investment Officer at Charter Trust Company and author of “The Global Market Update”. The audio version of each post can be heard on radio stations throughout New England every weekday. Mr. Tengdin graduated from Dartmouth College, Magna Cum Laude. He received his Master of Arts from Trinity Divinity School, Magna Cum Laude and received his Chartered Financial Analyst (CFA) designation in 1992. Mr. Tengdin has been managing investment portfolios for over 30 years, working for Bank of Boston, State Street Global Advisors, Citibank – Tunisia, and Banknorth Group. Throughout his career, Mr. Tengdin has emphasized helping clients manage their financial risks in difficult environments where they can profit from investing in diverse assets in diverse settings. –
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