Definition: The degree to which some measure of a company’s performance, such as sales, has increased in a year, expressed as a percentage, as follows:
(New value – Old Value) / Old Value * 100 (note: multiplying by 100 turns the result into a percentage)Example: GRW Corporation achieved sales of $150 million in its latest complete year. The year before that, its sales were $100 million. The rate of growth from one year to the next is:
($150 m – $100 m) / $100 m * 100 = $50 m / $100 m * 100, or 50%.
Investeach explains: The two most important growth measures for assessing how a company is doing are the rate of growth in sales and the rate of growth in earnings. Impressive sales growth shows that the company’s products and services are in high demand. Impressive earnings growth shows that the company is able to control costs and / or charge high enough prices that there is substantial profit left over for the shareholders.
It is important to note that maintaining a high rate of growth becomes more difficult with each passing year. Consider our example of GRW Corporation above. It achieved an impressive 50% rate of growth for the last complete year by adding $50 million to it sales. Now that its most recent sales are $150 million, it will have to add half of that (ie, 50%), or $75 million this year to maintain that same growth rate! In essence, companies become victims of their own success!
It is certainly possible for a growth rate be negative. For example, AIG’s sales were $110 billion in 2007 but only $11 billion in 2008. The growth rate was: ($11 – $110) / $110 * 100 = -$99 / $110 * 100, or -90%!
Finally, there are certain situations where the computation of rate of growth can be tricky. One is where the prior year’s measure of earnings is close to zero. This means a tiny denominator and a result that is astronomically high! Another tricky situation occurs when one of the measures for a year is actually negative. While a company’s sales are unlikely to be negative, its earnings certainly can be. Let’s say LSR Corporation has earnings of $10 million in one year and then a loss of $ 5 million in the most recent year. LSR’s rate of growth in earnings from year to year would be (-$5 m – $10 m) / $10 m * 100 = -$15 m / $10 m * 100, or -150%. In this regard, any company that suffers a drop in earnings of over 100% has actually swung to a loss.
Riddle me this:
1. What is the rate of growth in sales for a company that achieved $5 million in sales last year and $3 million the prior year?
2. What is the rate of growth in earnings for a company that achieved earnings of $1 million in the latest year and $800,000 the year before that?
3. Why is the rate of growth in a company’s sales important for investors to know?
4. Why is the rate of growth in a company’s earnings important for investors to know?
5. Why do we say that over the course of several years companies become victims of their own success?
6. What two situations can cause a strange result when calculating a rate of growth?