Growth Without Profits Or Profits Without Growth?

17 Oct 2011

As an investor, would you rather put money in a growing business without profits or a profitable business without growth?  Which one would you join as CEO?

We have had some great discussions and debates over the past few months on this very question with a myriad of executives and investors. Some argue that growth without profits is pure folly; and we agree that ultimately businesses need to be both growing and profitable – but that is not the question we are asking. Would you rather have growth at the expense of profits or profits at the expense of growth?  Of course the easy and obvious answer is profitable growth. Of course too it depends at what stage of the companies life cycle you are in.

We think if you had to choose, it’s growth over profits from an shorter term investment standpoint (assuming a liquidity event on the horizon), not in the long term. Growth simply gives you more strategic options: (1) an ability to access to capital – both private and public, (2) an ability to attract great talent, (3) it gets your potential acquirers to sit up and take notice of you, and (4) it gets your competitors to panic and potentially make a mistake or two.

Growth is wind in your sails as it were. The Greek philosopher Hesiod once said “admire a small ship, but put your freight in a large one; for the larger the load, the greater will be the profit upon profit.”

Look, you can’t sell four quarters for a dollar and make it up in volume. Lots of businesses are unprofitable for a multiple of reasons, even though they are growing. Take Groupon for instance, their recent S1 says they are losing a whopping $750M annually. Clearly a highly unprofitable business isn’t unsustainable in the long run. We believe if a business is doing $1B top line revenue, growing strong, and not profitable, it’s most likely heading off a cliff. With that kind of revenue, the business should have found a sustainable way to exhibit profitability.

One conversation last week with a savvy CFO from a large public cap company got us to mutually agree that the argument can all be summed up as ‘it’s all just algebra’, meaning the best companies can dial in both growth and profits at a reasonably granular level.

We’re currently analyzing literally thousands of public company data by looking at both top-line revenue growth and EBITDA growth and measuring the correlation of growth to their enterprise value or other types of shareholder value. In other words, we want to understand, if top-line growth or EBITDA growth generates a disproportionate value to the shareholders compared to peer companies in the same sector.

Stay tuned, we hope to report some interesting insights later this Fall.

Thoughts?

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