How a company can grow its earnings?
A company can grow its earnings in different ways:
1- Sell more of its products/services.
2- Increase prices (pricing power).
3- Lowering costs.
4- Geographical expansion.
5- Increasing market share.
6- M&A.
It’s very important to know that not all growth is created equal.First and foremost, it’s important to understand that growth only creates value when the Return On Invested Capital (ROIC) of the company is higher than the Weighted Average Cost of Capital (WACC).In general, organic growth is the most preferred source of growth.
Why? Because it’s the most sustainable growth source:
It’s good that a company increases its earnings as a result of cutting costs or because it reduces its investments in R&D, but this growth source is not sustainable in the long term. A company can only cut its costs to a certain level for example.
Companies can only keep growing its earnings at attractive rates when they are able to grow its revenue organically at attractive rates. That’s why I personally seek for companies which can grow their revenue with at least 6% per year.
Don’t buy growth at any price:
While in the long term earnings growth is more important than valuation, it’s important to understand that you can’t buy growth at any price.
