What Defines a Growth Company?
A growth company is one whose business generates significant positive cash flows or earnings, increasingly at rates far beyond the overall economy. These companies often have highly profitable reinvestment opportunities for their retained earnings. Consequently, they usually pay little to no dividends to stockholders, preferring to channel most or all of their profits back into expanding the business.
Key Attributes of Growth Companies
- Growth companies generate positive cash flows or earnings faster than the overall economy.
- They typically reinvest earnings back into the company rather than paying out dividends, fostering continued growth.
- In contrast to mature companies, growth companies report rapidly growing earnings rather than stable or slow growth.
- Mature companies generally find it easier to obtain financing due to established business models and financial records.
- Investors in growth companies are less interested in dividend income and more focused on appreciation of the company’s share price.
- The tech sector today houses many notable growth companies.
Understanding a Growth Company
The technology sector exemplifies growth companies. Take Google for instance; since its initial public offering (IPO), it has consistently increased its revenues, cash flows, and earnings considerably.
Growth companies, also known colloquially as gazelles, play a pivotal role by driving market momentum through increasing revenues and profits. Unlike mature companies, such as utility firms reporting stable earnings with minimal growth, growth companies stand out.
These companies create long-term value by expanding above-average earnings, extending free cash flow, and ramping up research and development spending. Growth investors prioritize company sales growth and industry leadership over concerns like dividend growth and high price-to-earnings ratios.
Growth Companies Across Market Cycles
Bull Markets
During bull markets, growth stocks are often preferred—they tend to outperform value stocks because of low perceived market risks and high-growth environments.
Bear Markets
In bear markets, growth stocks generally underperform value stocks, as weak economic activity stifles sales growth—the engine driving their value. Established, mature companies often weather these downturns better due to entrenched market positions, devoted consumer bases, strong cash reserves, and proven credit.
Securing Capital
Mature entities have an easier time raising funds during tough economic times due to their established nature, whereas growth firms usually rely more on venture capital or angel investors, crucial for surviving tough markets.
Real-World Examples
Many growth companies are prominent in the tech sector due to the rapid pace of innovation and aggressive growth spending. Examples include:
- Google (GOOGL): Google continuously expands its tech dominance by delving into new sectors like artificial intelligence.
- Tesla (TSLA): As a leader in the electric vehicle market, Tesla stands distinguished in its industry.
- Amazon (AMZN): Amazon is a disrupting force in retail with its robust e-commerce platform, overshadowing many traditional retailers.
These examples illustrate that despite once fitting classic ‘growth company’ profiles, they are now fairly mature within their industries and are counted as substantial, solid investments.
Moreover, growth firms are not limited to one industry. For example, Etsy (ETSY), an e-commerce retail platform, has marked its growth trajectory by specializing in vintage and craft items.
Related Terms: IPO, venture capital, angel investors, bear markets, bull markets.
