I was asked this in an interview recently and am interested in how yall would have answered this.
growth is only good if the firm is exceeding its cost of capital, otherwise it destroys value
Yeah I was an econ major so I probably would have said: Growth is good as long as it doesn’t exhibit diminishing marginal returns at a certain point, or is good up to that point. The question made me immediately think about the money supply. I need to get off this forum!
Growth in what? My answer would have been something like: Growth cannot be examined by itself. We need to asses whether we are growing for the sake of growing. Are we veering away from core strategies to simply get bigger? What about margins? Are we taking on too much unneccesary or unacceptable risks in order to achieve this growth? If we are trying to take market share, are we running the risks of crossing the lines of anti-trust? Reggie makes a good point about diminishing returns, but even in that context, it could be beneficial in the long run to grow while experiencing diminishing returns if competition is being driven out in the near term. In short, the answer would have been a resounding NO, but the reason why would have to be dependent upon the context of the growth.
soma80 Wrote: ------------------------------------------------------- > growth is only good if the firm is exceeding its > cost of capital, otherwise it destroys value That is basically what I said. I said growth is good when ROE > k. When ROE < k, I said it is better to increase the payout ratio which will in turn lower the growth rate. I didn’t get much of a reaction out of him, so I wasn’t sure if I was missing something.
MT327 Wrote: ------------------------------------------------------- > soma80 Wrote: > -------------------------------------------------- > > I didn’t get much of a reaction out of him, so I > wasn’t sure if I was missing something. I think you are missing something. You need to think outside the realm of the textbook answer, and consider practicalities. Even if you are creating weath with ROE > k, the risks you could be taking on, the means by which you are achieving that growth, and the external effects of the growth must be considered as well. It is not a simple math relationship, but much more complex in reality.
when im with my shorty growth is always appreciated.
wyantjs Wrote: ------------------------------------------------------- > MT327 Wrote: > -------------------------------------------------- > ----- > > soma80 Wrote: > > > -------------------------------------------------- > > > > > > I didn’t get much of a reaction out of him, so > I > > wasn’t sure if I was missing something. > > > I think you are missing something. You need to > think outside the realm of the textbook answer, > and consider practicalities. Even if you are > creating weath with ROE > k, the risks you could > be taking on, the means by which you are achieving > that growth, and the external effects of the > growth must be considered as well. It is not a > simple math relationship, but much more complex in > reality. I agree. In fact I did bring up the issue of risk using the current financial crisis as an example. Specifically I discussed leverage and what it did to Lehman. I forgot that I had made that point before you reminded me!
MT327 Wrote: I said growth is > good when ROE > k. When ROE < k, I said it is > better to increase the payout ratio which will in > turn lower the growth rate. > > I didn’t get much of a reaction out of him, so I > wasn’t sure if I was missing something. Really depends who you are talking to, I am imagining saying this when being interviewed by the HR person…blank stare. This is a very finance-math type of answer, no reaction could mean he was thinking in a totally different way.
HR would never ask such a question. It’s more behavioral type of questions.
I would have answered by talking about the sustainable growth rate [SGR = ROE * (1 - Payout Ratio)], etc. Growth is good if the company doesn’t grow itself into bankruptcy, basically. Maybe say something like: “Generally, growth is a good thing, so long as the firm is not exceeding it’s sustainable growth rate. If a firm sees good opportunities for growth that would require it to grow faster than it’s SGR, then the firm should consider adjusting its payout ratio. In theory, shareholders should be indifferent to the dividend payout, so long as the company is meeting it’s cost of capital hurdle rate. If the firm cannot feasibly adjust its dividend payout ratio, either due to shareholder demands, or because the firm is already retaining 100% of earnings, then the firm would have to be able to increase it’s ROE to be able to take advantage of the growth opportunity. If this is the case, then growth (or at least the potential for growth) is good, because it will lead management to maximize the long-term ROE and ultimately maximize shareholder wealth.”
Not when it’s a tumor…
^ hilarious!
Growth in a dying industry is not good.
i wonder what reaction you’ll get if you have said “Not when it’s a tumor…” haha
The reaction would be that you’d get hired. The tumor answer is way better than the financial math answer.
Growth for the sake of growing may not be a good thing. I guess you could have asked whether he was referring to internal or external growth. Historically, companies have attempted to hide operating issues with mass amounts of acquisitions. If a company is acquiring other companies, and there doesn’t appear to be any logical strategic reasoning for the acquisitions, that would be serious red flag. I wouldn’t view that kind of growth as being positive. On a side note: Even if the acquisitions did make sense from a strategic standpoint, analyzing the consolidated statements can be a real pain in the @ss as a time series analysis is now much less meaningful. Also, CFO tends to be overstated (as there was a CFI outflow to purchase a company. Its receivables will be treated as a CFO inflow when collected).
I thought he meant growth vs. value style mandates. I would say that sure, growth has been giving it to value for a while now and I’m starting to hear the odd “value is deep” comment, which is exactly why I am starting to value tilt my portfolios. Willy
Willy, read Active Value Investing if you haven’t already. You’ll like it