Does Higher Revenue Growth Generate Higher Value To Investors?
We have long believed at Milestone Group that investors are generally better off investing in the fastest growing companies in a given sector and that these companies generate better returns than their peers. We have decided to see if that’s actually true and measure correlations between revenue growth and valuation.
We recently met with a leading venture capital firm. Interestingly, at the end of every quarter the partners look at year-over-year quarterly revenue growth for each of their portfolio company in an aggregated way. In other words, the firm calculates the sum of the revenue of all their portfolio companies and compares it to the same quarter a year ago. What they discovered was amazing: the correlation of the portfolio value percentage difference between the current quarter and the same quarter a year ago was pretty much the same as the percentage of the aggregated revenue change. For instance, if for the March quarter the aggregate revenue of their portfolio grew from $250M this year to $400M last year, i.e. growth rate of 60%, the portfolio value would also grow at about the same 60% rate.
So, we asked ourselves the following question: what would the same correlation analysis tell us for publicly traded companies?
Of course, as always the devil is in the detail. The exercise has to be done carefully to be able to compare apples to apples. One must take into account currency exchange rates at various time, inflation / deflation to compare the value of the same currency at different periods of time; compare market capitalization or enterprise value growth relative to the exchange growth.
As we are embarking in this detailed analysis, we decide to look at one simple example of two companies driving the bulk of a market: the one for commercial large body airplanes: Boeing (NYSE: BA) and Airbus. This oligopolistic industry simplifies the analysis, because of the highly concentrated market (high Herfindahl index). Airbus is now part of EADS (European Aeronautic Defense and Space) that was formed in July 2000 and is trading on the French public market under the symbol EADS. In 2010, Airbus represented 66% of EADS’ revenue and commercial planes represented 50% of Boeing.
From 2001 to 2010, EADS grew its top-line revenue at a CAGR of 4.5% and generated €45.8 billion in revenue in 2010. During the same period, Boeing grew at a CAGR of 1.2% to generate $63.3B in 2010, so EADS grew at 3.8 times faster than Boeing during that time. EADS market cap grew, during the same time at a CAGR of 2.9% compared to 3.0% for Boeing. One can’t compare the growth of the market cap of both companies since they are trading on different exchanges, with different investors, under different rules, different economic and political climates and arguably with different valuation models. So, one must look at the stock performance relative to the market the stock is trading in. From 2001 to 2010, the CAC40 market lost value at a -3.3% CAGR and the NYSE market grew at a 1.3% CAGR rate. So, a dollar invested in EADS would generate $0.55 more than the same dollar invested in the French market and a dollar invested in Boeing would only have generated $0.18 more than the NYSE market. In other words, EADS outperformed the market by a factor of 3.1 compared to Boing in its US market. Interestingly, this is fairly close to the revenue growth ratio of 3.8.
It’s a simple example, but it does show that the fastest growing company is outperforming the market compared to its competitor. While there are exceptions, we believe that there is a good correlation between relative returns to investors and the company’s growth rate. Further research we are currently undertaking will help us determine if this is generally true or not.
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