The growth imperative
The following thoughts seem obvious to me, but I know that many intelligent people haven't really encountered them and that much business and economic writing seem to ignore them. Therefore, please forgive me if they seem too obvious to you.
- All publicly held companies have as their main purpose a return to the investors. There may be nominally in the business of media, manufacturing, or accounting, but they are deeply and thoroughly in the business of enhancing the wealth of stockholders.
- There are two standard ways to reach that goal- by returning cash payments to stockholders (dividends) or by increasing stock prices. Naturally, many companies combine both approaches, but we will treat them here as separate paths.
- The dividend route is what is commonly called a value stocks. These are usually mature companies in mature businesses, where the opportunities for growth are limited but where the cash flow is good and reliable. Stockholders are invest because they get a regular cash return that outpaces normal interest rates for bonds or savings. The price of each individual stock share is based on the presumed cash return.
- For all other companies, so-called growth companies, the price of each individual stock is based on the prospect that stock will be worth more next year than it is now. That price is a form of gambling on the future growth of the company and its assets. Stock buyers are not paying of the current value of the company's shares, but on their potential value. In this way, (new) companies that lose money can have value if the perception is that in a few years they will do better than break even.
- The management of such companies are under enormous pressure to ensure steady and regular growth. Much of the expertise of the stock market and the gyrations of corporate investment relations is in predicting exactly how much that growth will be and then whether it will make or miss the consensus target for growth. Management's jobs are, to a great extent, based on their ability to meet these goals. This leads to major temptations to fudging and even fraud, as we have seen over and over.
- There are two ways to grow, either in terms of net income (profit), gross income, or acquisition value. In the best scenario you do all three. Net income gains normally come through cost cutting and productivity gains. Gross income growth can come in several ways: by taking market share from the competition, selling new products and services, or opening new markets.
- While net income may increase when gross income increases, there is usually a lag. That is due to the need to add resources in order to expand, and it can take years to recoup the expenditure of expansion.
- The easiest way to add to gross income is through mergers and acquisitions. Buying an established business with developed products and markets is a lot easier than internal innovation. Many companies add 30%, 50% even 100% to the gross income line simply by making a purchase.
Of course, the immediate effect on the income is usually negative. Cash reserves are swallowed up, debt is loaded on, more stocks are issued. That is why most acquisitions cause an immediate drop in the stock price of the buyer.
The pressure to grow at any cost can lead to foolish acquisitions. The folly of those acquisitions may not be apparent for years. It is also true that growth can have side benefits (including a bigger say in public policy and a stronger bargaining position with suppliers and customers) than can outweigh the immediate loss in income.
The problem is that even when a company has grown this year, and done a good job in integrating the acquisition and cutting costs, there is always next year. At some point after every acquisition, the "what have you done for me lately?' question comes up. The management is under pressure to grow again.
Even a decrease in the rate of growth is a problem. When a successful company grows merely by 5% in a quarter in terms of gross income, rather than 7%, that slip is seen as a failure. Of course, this year's growth is based on a higher starting figure. That's another reason to grow by acquisition.
At some point, growth in gross income has to translate into gross in net income. That day can be put off, but it cannot be avoided. Until then, new acquisitions can cover the fact of low or negative growth.
I found this apropos entry from a Web site called Ideoplex, a posting that says much the same thing:
One of the problems with being a public company is the pressure to Grow or Die. The shareholders want growth to justify a higher multiple for the share price. The executive staff wants growth to satisfy their ambitions. And the employees want growth to fuel promotions and raises. Unfortunately, organic growth is hard. It's tempting to grow by acquisition. And it's way too easy to make a stupid acquisition.
4:39:47 PM 
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