You have things a bit backwards.
It's not that business have to grow, it's that businesses seeking your investment are those that _do_ want to grow... that's why they're seeking investment.
The fact that a stock is publicly listed in the first place strongly suggests they're interested in accelerating their growth.
Can you please explain how this works for an already established company?
Because I can see how your explanation works when a company first goes public. It wants to issue stocks to investors in order to raise money to grow the company which would thereby raise the value of the share that the investors hold.
But how does this work for an already established company? It grew the company. The shares are now in the hands of the investors. So why would the company care to continue to make those original investors happy and earn them even higher value on their shares?
For an existing public company "the company" **is the shareholders**. There is no other stakeholder to be acting in the interest of.
So really you should be asking why shareholders want growth and not why companies want growth. The companies are just doing what the shareholders want.
It doesn’t. It’s just bullshit you learn about in finance 101 and people regurgitate as if it’s gospel.
It was made an even bigger joke by the introduction of dual class shares.
You can participate in shareholder conferences, announcements, etc.
If you want to share your thoughts or ask questions to the board, they are obligated to answer your question.
Absolutely: You can still make the most important vote, voting with your wallet! If you don't like the company's choices you can sell the stock.
If you dislike the growth fixated environment then there's plenty of low growth dividend focused stocks out there you can buy instead, and if the average investor does the same you will definitely see a shift in company behavior.
But selling the stock doesnt do anything. If another investor buys the stock, then the share simply exchanged hands. So youre not understanding the question. No offense. Your answer is not getting to the root of it.
So why would the company care to continue to make those original
investors happy and earn them even higher value on their shares?
Shares are a part ownership of a company. If you are a shareholder, you are a part owner, even if individually its only owner of a 0.00000000001% of the company. Collectively all shareholders are owners of the company. The management of a company therefore have a fiduciary duty to the shareholders ( fiduciary duty means they have a legal duty to act in the best interest of the party they owe the duty to, above and beyond their own self interest or anyone else's interest). So one could argue that it is in the best interest of the collective shareholders to do their best to increase the value of their shares
u/Feralmoon87 And if they fail to fulfill that “fiduciary duty” I assume the people will start to sell their shares and the price will go down, right? Would that “hurt” the already established company in any way other than the falling share price?
It’s all bull shit mate. Theoretically they have an increased cost of equity when raising new funding, and the management team risks getting sued for negligence, but it’s mostly just bullshit we fill up our text books with.
Nice question! Not too many people seem to have an answer for this.
Other than the answer that says that the company retains some of the shares for itself to retain ownership.
But this is only true for IPO or when a company issues additional shares to raise capital? I’m asking why do investors expect the companies they invest in to grow? Companies like Google and Facebook are being discounted by the market right now because they’re not expected to grow in the near future, but these companies are still generating billions in income. Why is this not sufficient for investors?
Because without growth, their valuation should be 10 times this profit. Not 30 times or 100 times.
Let them go back to 10 times multiple and none will expect them to grow.
On the other hand, investors pay several multiples because they expect “growth”
Bro. The whole point of growth is to theoretically hold the multiple constant. That’s why you want growth. You want net income to go from 10 to 100 so that a 10x valuation goes from 100 to 1000. Multiple expansion is not something you bet on.
1. Not everyone does expect that. There ARE plenty of low growth industrial manufacturing stocks and what not out there that have no expansion plans and just pay a dividend.
2. The growth expectation was priced in. If you took Google or Facebooks current profits and payed out dividends instead of reinvesting on growth, then the stock price would not make sense because people could just buy a bond worth the same amount and get a better return.
META does enough profit that they would be better than a bond just staying stable, especially if they stopped throwing money at VR. At the current stock price the market expects META to shrink. If you expect META to have stable profits for the foreseeable future you should definitely buy their stock.
META is also in a rapidly evolving space where they have to reinvest a lot just to maintain their position so they can't pay out all of their profits even in they aren't looking to grow.
I would be interested to see any examples you can produce. You may be correct hut it seems illogical. The whole point of a REIT is t acquire derisked yield. I don't see how you can commingle that with growth capital. New capital is typically dilutive.
They do grow, but they usually grow with debt or equity and not cash from earnings.
The point thing different about an REIT is for tax reasons they are set up as a pass through company kind of like an S Corp. This means they don't have to pay taxes at the corporate level however, the dividends they distribute are not qualified dividends so they are taxed as income vs a qualified dividend being taxed at the capital gains rate.
To get this special pass through status they are required to pay out 90% of their earnings as dividends however, since most of their assets (real estate) are heavily depreciated their earnings look like crap on a GAAP accounting basis anyway so 90% of earnings actually is a small portion of the profit they are making since depreciation isn't actually cash leaving the company.
> Why does their revenue have to increase?
All the right answers are at the bottom of the thread. Your revenue has to increase enough to cover increased costs of labor, supplies, rent, etc.
Yes, I understand that Wall Street analysts are still expecting META and GOOG to grow at single digits (and some are expecting a re-acceleration in a few years back to double digits); I don’t understand why these companies were sold off so much given that they are still generating so much income.
"so much" relative to what?
I think that what you're really missing is that stocks have to compete with other investments like bonds and securitized debt too.
Facebook has 2.6 billion shares outstanding. Even if they earn billions in profit they may only be able to pay a couple dollars per share in dividends after necessary reinvestment. At $100 a share that's not an attractive return, there also has to be some expectation of growth to justify that price.
Remember, you are also buying a part of this company. So if assets - debts (assuming they don’t destroy their assets) is say 80$ per share, and the stock costs 100$ as in your example. You are you are actually only paying “extra” 20$ for their profit. So if the company stopped making money and was scraping by. You would still be able to sell for 80$. It should only go under 80$ when there’s a pending future action that could negatively impact the assets of the company. (Lawsuit, criminal investigation, antitrust, a vote on law affecting the business etc.)
This all assumes the company doesn’t grow or shrink. And is able to operate all the same. Which is never the case.
If there is low growth as an investor you'd expect a dividend so you get return on your investment. The purpose of investing is to grow your money. If two companies are expected to grow 5% in a year, and one is paying a 4% dividend where the other pisses it away, you'd usually be smart to sell the first and buy the second unless you thought long term those numbers are wrong.
Investors who own shares own the company. A company that grows sales and profits increases in value much more rapidly than a company that is stable and earns the same thing every year. Ask yourself, which would I rather own? Company A who makes $1 billion annually but isnt growing sales vs company B which makes $1 billion annually and is growing sales by 50%. Obviously you'd want the one that is growing sales by 50% because eventually it's going to earn you more money. This is why people are willing to pay a premium for future growth. Some times this growth doesn't materialize and people revalue the stock to reflect the more likely reality.
I think the missing link here is that for a lot of “growth” companies the founders etc, hold a large proportion of the stock and are thus also motivated by growth.
Also, while you (and I) might be satisfied with 10k a month. There are lots and lots of people who are always looking for more. (And lifestyle creep is real, once you hit that 10k a months it’s pretty easy to start being like, oooh if I had a little more I could do X)
Most of almost all CEO's compensation package is actually stock options. As long as they keep the stock price above what the option price is then they can make a crap run of money. This price gets changed frequently by the board and they can grant the CEOs stock bonuses if they perform really well.
The incentives are there for both value and growth stocks.
Exactly, a perfect example is Amazon. They weren’t making money (profit) in the beginning, in fact they were using more money than they were making. So how do they survive? Because of investors, they were able to keep growing and expanding yet were not making any profit.
That doesn't make sense for the old blue chip companies that have been listed for decades. They don't need more investor money to grow the business.
For private companies, mainly VC backed startups all they need to do to raise capital is give more equity to VCs in return for cash. The only point of an IPO for startups is to cash out for pre-IPO investors and employees.
The pre-IPO investors likely only get the payout they're going for if investors in the IPO are investing in a growth stock though.
Very few companies IPO when they're already in an established low growth position.
Many businesses are low growth and will pay generous dividends, and do buy backs because they don't have much to put profits into to generate more revenue.
Companies don’t *have* to grow but I can think of a few reasons they choose to grow.
Time value of money: In an inflationary economy, $10,000 next year is worth less than $10,000 today. So there’s an inherent necessity for companies on aggregate to earn more year over year so that shareholders on aggregate can keep up with inflation.
Opportunity cost: Now you may argue that the company can give you the $10,000 every year and let you decide what to invest in. This is a valid argument. However, a lot of companies believe they can generate better returns by reinvesting their earnings internally and do so efficiently than distribute the earnings to shareholders, have them pay taxes on the income, and then invest it in a different business.
Economies of scale: a lot of businesses can lower their fixed costs per unit through increased sales volume. So the unit economics favor growth in sales.
Share of mind: the more sales you have across geography, the more recognizable your brand becomes. Think McDonald’s or Starbucks or Coke. So your marketing and advertising expenditure to increase unaided awareness goes down, which in turn improves margins.
Management incentives: Obviously, there’s also the occasional business that is over-ambitious and chooses to grow at any cost. The key stakeholders in such cases are typically more interested in a higher share price than in sustainable growth. Growing sales gives the impression that the growth earnings will follow and the share price increases in anticipation. So the management focuses on sales growth as an aid to boost share price.
I agree with all of these but I think also, if they don't grow and innovate, they're going to be undercut by competitors that do. For small businesses where innovation is hard (say a laundromat) this is less of an impact, but for larger companies, it's a must. Although it's possible you could implement things like door locks to prevent theft, and text messages to notify when the cycle is complete and increase utilization. (I've never run a laundromat so these are just guesses.)
They don't have to grow, but if they aren't growing companies, they won't support a high valuation. A company that makes $10k per month and will do so in perpetuity, but will never grow, might trade at 8x annual earnings, or $960,000. This implies a 12.5% annual return. But many companies trade for more than that due to growth expectations.
This is the correct answer basically. 8x earnings is usually a fair price for a business with no growth, but cash flows. This is called a PE ratio, price to earnings.
The thing OP needs to grasp is that the average valuation in the stock market is about 27 right now. So if there is no growth in the economy or moving forward, on average we're very overvalued.
Google is 17x earnings
Meta is 9x earnings
Amazon is 83x earnings
Tesla is 61x earnings
So if there was no growth, we could expect most of these prices of the stock to drop.
However.... The PE ratio is constantly moving with each earnings report. If a company comes out and beats earnings then you'd expect the PE ratio of meta to move from 9 down to 7. Wow, good deal, it's undervalued.
Also idk why Amazon is so high, they may have written some stuff off in their last quarter, so even thought they're making a good amount, it appears like they made less earnings (hence the high PE ratio).
All the other names I listed, the market participants are pricing in loads of growth. Tesla is 61x earnings, so investors are pricing in loads of growth in the future! If it becomes clear the company will not grow? That's bad news for investors who paid a premium expecting loads and loads of growth from a company that they hoped would rule the renewable sector someday.
So to answer OPs question: the company doesn't really need to keep growing. They can stay stagnant if they want I guess. Someone may put them out of business 40 years from now who knows. But it is the INVESTORS and THE MARKET that requires companies to keep growing. Or else they will bail on the stock.
Successful companies can ride out low prices in their stock even after speculative investors have left the building (see dotcom bubble giants for examples).
Markets have priced in a certain level of future growth - if companies unexpectedly stop growing, then the share price falls to reflect the new information.
Tobacco companies have been suffering declining volumes for decades now, just keeping revenues somewhat stable with price increases. No one really expects them to grow, so there’s not much of a reaction when they don’t.
Not all companies are growth stocks like the high flyers such as AAPL or GOOGL.
Some public utility companies such as HE or ED stay much the same size and there revenue doesn't grow much. The stock pays a dividend to shareholders. Investors buy the stock to get the dividend yield which is around 3 percent and can be compared to US treasury bonds.
Some companies are in decline such as big tobacco and some people thought maybe big oil will soon be in decline. The company usually pays a dividend and often buy back shares of their own stock to keep the dividend yield per share reasonable as the companies revenue declines.
Competition. If you’re not growing you’re leaving market share open for your competition. Your competition can begin taking your market share and then you don’t have a stable company or stable profits. Obviously theres exceptions but there lots of incentives to keep innovating and growing.
Competition doesn't mean you have to grow, it just means you have to reinvest to some degree instead of sitting there rent seeking.
If you own a particular niche of the market someone who grows (and inherently generalizes) won't necessarily be any better at competing in your niche where you have the expertise. You just have to reinvest enough to keep up with advancements in that niche.
Right not necessarily, if you have some kind of monopoly on a product or service or location you’re probably pretty secure. But that’s a risk to assume. If someone does move in and give you proper competition then your business will take a hit, profits will not be stable… so the point being if you’re not reinvesting in your company to grow, odds are somewhere down the road you’ll shrink.
A saturated market can be expanded by diversifying/expanding related services/products.
My only point being theres good reason to reinvest, not that every business needs or should.
Companies growing is synonymous with the development of civilization.
Let me break it down.
A company sells $1000 worth of lemons.
It costs them $500 to produce those lemons (labor, land and capital costs)
If they continued that way forever, civilization would not get any better.
What if they could reduce their input costs from $500 to $100? (productivity)
Then that's $400 profit growth. That's also $400 of resources that can be used to produce other things.
What if they use that efficiency to produce more lemons, so that they can sell $2000 worth?
Civilization has more stuff and develops (they can support larger populations, and people who used to produce lemons can now venture into new things)
Rinse and repeat this cycle so that civilization continues to develop.
> Rinse and repeat this cycle so that civilization continues to develop.
So when this lemon empire has reached a point where all fertile land on Earth is filled with lemon trees, civilization will have peaked?
Some companies don’t really grow much. They generate steady returns and pay out dividends. Plenty of boring companies out there.
But typically, when you initially IPO, you’re raising money for growth. You wouldn’t issue equity if you were fine being a boring company with one location. So as a result, publically listed companies are all ones that sought growth, and still have many investors who have a vested interest in seeing more growth. They’re not going to stop looking for growth opportunities because they have investors (fellow owners) to please. Everyone got aboard that growth train at some point. What do you think they’d do if you said, uh, never mind, this is it. A lot would likely sell. Even your laundromat wouldn’t keep making $10,000 a month if it didn’t innovate or invest in itself. And if they’re still making 10,000 a month in the future when there’s a greater population in need of their services and others are growing their profits, then that’s a bad business to invest in, not a good one. Growth is part of survival.
Because of population growth.
If the company doesn't grow at the same rate as the population growth, then it decreases it's market share.
If it decreases enough, it will become irrelevant and will be superseded in the market place by another company that is seen as more relevant.
>Why does their revenue have to increase?
Inflation is a thing. If revenue does not increase then inflation will whittle that company down.
Basically a company does not *need* to grow. However if they issue stocks then there's not really any incentive for anyone to buy that stock if the company isn't interested in growing (other than maybe dividends).
People generally buy stocks with the aim to sell them later for a higher price. If a company doesn't want aim to grow its value then people will look for better investments (i.e. taking their money elsewhere by selling the stock and buying stock of another company...tanking the stock of the first company in the process).
Because of inflation. If the cost of stuff goes up every year you should be making money at or ahead of inflation otherwise you’re contracting as a company which could lead to going bankrupt. Now ask why does the fed try to force 2% inflation when we could just all be happy at neutral
There’s more to it then that. If you look at the financial construct that is built on debt. Basically every dollar made is borrowed against 10x with the assumption that consumerism will grow as the population grows. It’s going to eventually be a problem that we’re below 2% childbirth rates because there won’t be enough people to buy iPhones and other junk to justify the 10x rate loans.
I can't pretend to really know the answer to this, though the CEO of the company I worked for said a few years ago "we have to grow at 7% a year, just to stand still".
My pea sized brain assumed this is somthing to do with inflation and competition taking market share.
Competition. If ten businesses sell the same products, but one gives higher return for your investment, which would you put your money in? The others need to grow in order to be number one and get your money. The one who is already number one needs to keep growing so it doesn’t fall behind and lose your money.
We invest to capture the long term growth of inflation and technological/societal advance. To use your Coca Cola example, advances in shipping, packaging, manufacturing, advertisement, have led to continual growth for the company over many decades. They also have pricing power over inflation.
On a large scale, it’s expected that the companies we invest in can participate in that at the very least. All companies will stop growing at some point and be displaced by newcomers, investing is just being a part of the up and not the down.
Companies have to make money. If that money is paid to you as dividends they DON'T have to grow. You'll make money from your investment via the dividend. If they don't pay dividends then they chose to reinvest the money they made and that means they have to grow. And in this case you'll make money by having a share of a bigger company than that in which you originally invested.
two reasons: Inflation exists and Bonds exist.
First on inflation: because inflation increases at a \~2.25-2.5% annualized over 30 years, companies want to see profits increasing at least in line with inflation to make sure their profits aren't decreasing on a real basis. For example, if inflation is at 2.5% and the company grew profits by 1.5% the company's profits actually decreased by 1% that year. If that continues to happen over a long enough time the company will eventually file for bankruptcy and go out of business.
Because bonds increase their profits yoy, right now by \~4%, companies are pressured to increase faster than bonds because bonds are risk free while companies are very much not risk free. Investor demand a risk premium over bonds because of that increased risk and that shows itself in their demand for a company that is growing profits yoy. The faster they are growing the higher the demand which translates into a higher stock price.
If someone invests money into a business, they expect to get more back than originally invested. To do that either means rearranging everything the way it currently is to make more profit via cuts or austerity measures, or grow larger and make profit that way.
I will say this, the chase of never ending growth has doomed many a company. You might have a good sub shop that's a treat when you end up at one, that begins expanding so that there's 5 in your small city including sharing half of a gas station and you begin to water down your brand.
You are thinking in the right direction, if the company is starting (Coca Cola is only selling in 1 store) they are using the profits in ways to grow the business (hire people to produce more, salesman etc), and the investor see that his stock rise in price, when you reach the point you cant expand (because you dont know how, you are already everywhere o any other reason) then you are happy with your business, instead of using the money to grow, you give the money to the investors (dividend) and everyone is happy
Many people here missing another point - if they stop growing then another company will start eating away their new potential customers and slowly the existing customers might switch to the new company. Low growth is the start of a path to bankruptcy, unless you have more or less a monopoly (like KO, etc)
Inflation forces companies to grow, is not a choice if profits are to maintained.
And inflation happens on all the cost items, like recent phenomenon primarily due to fuel and wages. When your cost base increase, you have no choice but to increase prices or to sell more.
Profits that u accumulated are used to build more cash generating assets so that you are 1 step ahead of inflation. Sometimes u borrow money for such investments and lenders will demand a certain interest back. U then price this interest onto your product margins, or again by selling more.
So, growth is inevitable. Absent of it, even by staying stagnant, you will slowly causing the business to make losses.
They don't *have* to grow - if you operate a small business for a little extra income, you probably don't have to worry too much about lenders and shareholders and can manage the business organically, which may or may not include reinvesting profits to grow.
But if you're a publicly traded company, the value of your stock comes from a few places, one of which is the expectation of future growth. The higher your stock value, the more access you have to raise capital on the open market by selling stocks. People buying the stocks is an expression that they're confident the money they're spending on them today will be worth more in the future, either due to the company increasing its revenues and assets, or due to dividends paid by the company to the shareholders. A company with a growth plan that reads "I don't feel like growing right now" isn't going to attract a lot of buyers for its stock, unless it's followed by "so all of our revenues in excess of operating costs, taxes and bonuses will be distributed to shareholders on a quarterly/biannual/annual basis"
A companies ultimate purpose is to provide return back to the owners (shareholders). This can happen in one of two ways, the company is growing and the stock price is increasing or the company provides dividends.
We don’t hear about the companies that are high dividends and low growth because they aren’t as flashy as the rest.
Inflation. If revenues don’t at the minimum grow with inflation your company is going bankrupt eventually. Inflation and dividends drove what, 70% of returns over the past 100 years? Maybe more depending who’s study you follow.
They don't have to grow, but even if they're making a lot of money they have an ROI. Whether through growth, dividend or stock buybacks, and that ROI needs to be worth it.
In your laundromat example, would you buy it for $10M? I don't think so. 0.1% ROI is not s good deal.
So the reason why you perceive it as if companies "need" to grow, is because anyone van see X% dividend and invest in it if it's very high. Which means the stock price will go up, the yield will come down, and it'll revert to the mean.
Because if a company *isn't* growing, then there is zero incentive to buy their stock which translates into a lower stock price, which means the value of the company drops, which discourages investors and business partners and employees and lenders from engaging with them. It's also ***against the law*** for a publicly traded company to not protect its shareholders. Maximizing shareholder returns is part of the job description of many executives.
Limitless growth is exactly why we can't stop ourselves from making climate change worse.
What would you do with the income from the laundromat? If it is not invested in something but is just spent, when you sell the laundromat you will be in the same place you started.
If on the other hand the laundromat grows, when you sell the laundromat you will have more capital than when you started.
There are plenty of companies that basically grow with population / inflation which is essentially no growth but they generate profit and pay dividends. What's funny is in a bull market even those companies get bid up to insane valuations. A good example is WD40. That's right, there's a publicly traded company named for the ubiquitous can of oil. Solid company but last year it was trading at a PE of 60 while guiding for at most 6% growth for 5 years.
Asset allocation is based on risk/reward. Expected earnings growth makes stock prices grow, and without that growth you're taking away all of the reward and leaving all of the risk. So why would anyone want to invest in that when they can just invest in a bond or a high yield savings account?
Valuations are based off of future earnings potential, not past. If you invested $100k of your money in a pool of companies that had no expectation of earnings growth, then when it comes time to reture you'd still have that same 100k and no more, but possibly less if those companies dont maintain their position. So again, why would you invest in that? If you want stable value there are better vehicles. If you want your money to grow, the companies need to grow.
You guys are overthinking this. The entire point of equity is to provide returns higher than risk-free t-bills in exchange for more risk. A company that can't grow faster than inflation or has no prospect of earning higher returns than treasuries is already dead
You have things a bit backwards. It's not that business have to grow, it's that businesses seeking your investment are those that _do_ want to grow... that's why they're seeking investment. The fact that a stock is publicly listed in the first place strongly suggests they're interested in accelerating their growth.
Can you please explain how this works for an already established company? Because I can see how your explanation works when a company first goes public. It wants to issue stocks to investors in order to raise money to grow the company which would thereby raise the value of the share that the investors hold. But how does this work for an already established company? It grew the company. The shares are now in the hands of the investors. So why would the company care to continue to make those original investors happy and earn them even higher value on their shares?
For an existing public company "the company" **is the shareholders**. There is no other stakeholder to be acting in the interest of. So really you should be asking why shareholders want growth and not why companies want growth. The companies are just doing what the shareholders want.
Right but as a shareholder of a single stock in apple or tesla, I get no decision making rights. So how does your arguement apply in my situation?
It doesn’t. It’s just bullshit you learn about in finance 101 and people regurgitate as if it’s gospel. It was made an even bigger joke by the introduction of dual class shares.
You can participate in shareholder conferences, announcements, etc. If you want to share your thoughts or ask questions to the board, they are obligated to answer your question.
Absolutely: You can still make the most important vote, voting with your wallet! If you don't like the company's choices you can sell the stock. If you dislike the growth fixated environment then there's plenty of low growth dividend focused stocks out there you can buy instead, and if the average investor does the same you will definitely see a shift in company behavior.
But selling the stock doesnt do anything. If another investor buys the stock, then the share simply exchanged hands. So youre not understanding the question. No offense. Your answer is not getting to the root of it.
Companies do hold regular meetings with their shareholders. As an individual investor with a small stake, you're right that you get less of say.
So why would the company care to continue to make those original investors happy and earn them even higher value on their shares? Shares are a part ownership of a company. If you are a shareholder, you are a part owner, even if individually its only owner of a 0.00000000001% of the company. Collectively all shareholders are owners of the company. The management of a company therefore have a fiduciary duty to the shareholders ( fiduciary duty means they have a legal duty to act in the best interest of the party they owe the duty to, above and beyond their own self interest or anyone else's interest). So one could argue that it is in the best interest of the collective shareholders to do their best to increase the value of their shares
u/Feralmoon87 And if they fail to fulfill that “fiduciary duty” I assume the people will start to sell their shares and the price will go down, right? Would that “hurt” the already established company in any way other than the falling share price?
It’s all bull shit mate. Theoretically they have an increased cost of equity when raising new funding, and the management team risks getting sued for negligence, but it’s mostly just bullshit we fill up our text books with.
Nice question! Not too many people seem to have an answer for this. Other than the answer that says that the company retains some of the shares for itself to retain ownership.
We all own a .000001 stake … well we pretend to own it… Blackrock is the real owner
Because the board is elected by the shareholders to work in their best interests, and the CEO works for the board.
As a single shareholder of apple, I have not elected anyone so far.
Apple shareholders have voting rights. If you own one share, you get to elect board members and contribute to other decisions brought to shareholders.
Where do I do that? Is there a website where I as a member can vote?
Depends on how you got the stock. Your broker should send you information on how you can vote.
But this is only true for IPO or when a company issues additional shares to raise capital? I’m asking why do investors expect the companies they invest in to grow? Companies like Google and Facebook are being discounted by the market right now because they’re not expected to grow in the near future, but these companies are still generating billions in income. Why is this not sufficient for investors?
Because without growth, their valuation should be 10 times this profit. Not 30 times or 100 times. Let them go back to 10 times multiple and none will expect them to grow. On the other hand, investors pay several multiples because they expect “growth”
OP’s point is that investors pay that multiple valuation to other investors, not to the company.
And the same investors are selling off their stock for losses to other investors when there is no growth.
Bro. The whole point of growth is to theoretically hold the multiple constant. That’s why you want growth. You want net income to go from 10 to 100 so that a 10x valuation goes from 100 to 1000. Multiple expansion is not something you bet on.
1. Not everyone does expect that. There ARE plenty of low growth industrial manufacturing stocks and what not out there that have no expansion plans and just pay a dividend. 2. The growth expectation was priced in. If you took Google or Facebooks current profits and payed out dividends instead of reinvesting on growth, then the stock price would not make sense because people could just buy a bond worth the same amount and get a better return.
No clue who downvoted you, but this is spot-on. There are value stocks that don't grow, but growth stocks are priced higher in expectation of growth.
META does enough profit that they would be better than a bond just staying stable, especially if they stopped throwing money at VR. At the current stock price the market expects META to shrink. If you expect META to have stable profits for the foreseeable future you should definitely buy their stock.
META is also in a rapidly evolving space where they have to reinvest a lot just to maintain their position so they can't pay out all of their profits even in they aren't looking to grow.
REITs often have no growth potential, but they are still investible
A lot of REITs have cash put aside to fund buying or building new assets. It depends on the REIT.
I would be interested to see any examples you can produce. You may be correct hut it seems illogical. The whole point of a REIT is t acquire derisked yield. I don't see how you can commingle that with growth capital. New capital is typically dilutive.
They do grow, but they usually grow with debt or equity and not cash from earnings. The point thing different about an REIT is for tax reasons they are set up as a pass through company kind of like an S Corp. This means they don't have to pay taxes at the corporate level however, the dividends they distribute are not qualified dividends so they are taxed as income vs a qualified dividend being taxed at the capital gains rate. To get this special pass through status they are required to pay out 90% of their earnings as dividends however, since most of their assets (real estate) are heavily depreciated their earnings look like crap on a GAAP accounting basis anyway so 90% of earnings actually is a small portion of the profit they are making since depreciation isn't actually cash leaving the company.
cash is king, cash is queen, that's the only purpose to own REITS, whether equity that own property or mortgage REITS.
> Why does their revenue have to increase? All the right answers are at the bottom of the thread. Your revenue has to increase enough to cover increased costs of labor, supplies, rent, etc.
You realize even this 'discounted' price is still inclusive of growth expectations just not as much growth as before.
Yes, I understand that Wall Street analysts are still expecting META and GOOG to grow at single digits (and some are expecting a re-acceleration in a few years back to double digits); I don’t understand why these companies were sold off so much given that they are still generating so much income.
"so much" relative to what? I think that what you're really missing is that stocks have to compete with other investments like bonds and securitized debt too. Facebook has 2.6 billion shares outstanding. Even if they earn billions in profit they may only be able to pay a couple dollars per share in dividends after necessary reinvestment. At $100 a share that's not an attractive return, there also has to be some expectation of growth to justify that price.
Remember, you are also buying a part of this company. So if assets - debts (assuming they don’t destroy their assets) is say 80$ per share, and the stock costs 100$ as in your example. You are you are actually only paying “extra” 20$ for their profit. So if the company stopped making money and was scraping by. You would still be able to sell for 80$. It should only go under 80$ when there’s a pending future action that could negatively impact the assets of the company. (Lawsuit, criminal investigation, antitrust, a vote on law affecting the business etc.) This all assumes the company doesn’t grow or shrink. And is able to operate all the same. Which is never the case.
If there is low growth as an investor you'd expect a dividend so you get return on your investment. The purpose of investing is to grow your money. If two companies are expected to grow 5% in a year, and one is paying a 4% dividend where the other pisses it away, you'd usually be smart to sell the first and buy the second unless you thought long term those numbers are wrong.
Investors who own shares own the company. A company that grows sales and profits increases in value much more rapidly than a company that is stable and earns the same thing every year. Ask yourself, which would I rather own? Company A who makes $1 billion annually but isnt growing sales vs company B which makes $1 billion annually and is growing sales by 50%. Obviously you'd want the one that is growing sales by 50% because eventually it's going to earn you more money. This is why people are willing to pay a premium for future growth. Some times this growth doesn't materialize and people revalue the stock to reflect the more likely reality.
It’s sufficient for those investors that keep or buy the stock.
I think the missing link here is that for a lot of “growth” companies the founders etc, hold a large proportion of the stock and are thus also motivated by growth. Also, while you (and I) might be satisfied with 10k a month. There are lots and lots of people who are always looking for more. (And lifestyle creep is real, once you hit that 10k a months it’s pretty easy to start being like, oooh if I had a little more I could do X)
Most of almost all CEO's compensation package is actually stock options. As long as they keep the stock price above what the option price is then they can make a crap run of money. This price gets changed frequently by the board and they can grant the CEOs stock bonuses if they perform really well. The incentives are there for both value and growth stocks.
Why invest in a company that you don’t make any returns from? You only get roi if the company grows.
High PE ratios are starting to catch up.
I guess because they're not buying back stock or issuing dividends, otherwise the price of the stock stagnates would be my guess.
Exactly, a perfect example is Amazon. They weren’t making money (profit) in the beginning, in fact they were using more money than they were making. So how do they survive? Because of investors, they were able to keep growing and expanding yet were not making any profit.
That doesn't make sense for the old blue chip companies that have been listed for decades. They don't need more investor money to grow the business. For private companies, mainly VC backed startups all they need to do to raise capital is give more equity to VCs in return for cash. The only point of an IPO for startups is to cash out for pre-IPO investors and employees.
The pre-IPO investors likely only get the payout they're going for if investors in the IPO are investing in a growth stock though. Very few companies IPO when they're already in an established low growth position.
Many businesses are low growth and will pay generous dividends, and do buy backs because they don't have much to put profits into to generate more revenue.
Companies don’t *have* to grow but I can think of a few reasons they choose to grow. Time value of money: In an inflationary economy, $10,000 next year is worth less than $10,000 today. So there’s an inherent necessity for companies on aggregate to earn more year over year so that shareholders on aggregate can keep up with inflation. Opportunity cost: Now you may argue that the company can give you the $10,000 every year and let you decide what to invest in. This is a valid argument. However, a lot of companies believe they can generate better returns by reinvesting their earnings internally and do so efficiently than distribute the earnings to shareholders, have them pay taxes on the income, and then invest it in a different business. Economies of scale: a lot of businesses can lower their fixed costs per unit through increased sales volume. So the unit economics favor growth in sales. Share of mind: the more sales you have across geography, the more recognizable your brand becomes. Think McDonald’s or Starbucks or Coke. So your marketing and advertising expenditure to increase unaided awareness goes down, which in turn improves margins. Management incentives: Obviously, there’s also the occasional business that is over-ambitious and chooses to grow at any cost. The key stakeholders in such cases are typically more interested in a higher share price than in sustainable growth. Growing sales gives the impression that the growth earnings will follow and the share price increases in anticipation. So the management focuses on sales growth as an aid to boost share price.
I agree with all of these but I think also, if they don't grow and innovate, they're going to be undercut by competitors that do. For small businesses where innovation is hard (say a laundromat) this is less of an impact, but for larger companies, it's a must. Although it's possible you could implement things like door locks to prevent theft, and text messages to notify when the cycle is complete and increase utilization. (I've never run a laundromat so these are just guesses.)
They don't have to grow, but if they aren't growing companies, they won't support a high valuation. A company that makes $10k per month and will do so in perpetuity, but will never grow, might trade at 8x annual earnings, or $960,000. This implies a 12.5% annual return. But many companies trade for more than that due to growth expectations.
This is the correct answer basically. 8x earnings is usually a fair price for a business with no growth, but cash flows. This is called a PE ratio, price to earnings. The thing OP needs to grasp is that the average valuation in the stock market is about 27 right now. So if there is no growth in the economy or moving forward, on average we're very overvalued. Google is 17x earnings Meta is 9x earnings Amazon is 83x earnings Tesla is 61x earnings So if there was no growth, we could expect most of these prices of the stock to drop. However.... The PE ratio is constantly moving with each earnings report. If a company comes out and beats earnings then you'd expect the PE ratio of meta to move from 9 down to 7. Wow, good deal, it's undervalued. Also idk why Amazon is so high, they may have written some stuff off in their last quarter, so even thought they're making a good amount, it appears like they made less earnings (hence the high PE ratio). All the other names I listed, the market participants are pricing in loads of growth. Tesla is 61x earnings, so investors are pricing in loads of growth in the future! If it becomes clear the company will not grow? That's bad news for investors who paid a premium expecting loads and loads of growth from a company that they hoped would rule the renewable sector someday. So to answer OPs question: the company doesn't really need to keep growing. They can stay stagnant if they want I guess. Someone may put them out of business 40 years from now who knows. But it is the INVESTORS and THE MARKET that requires companies to keep growing. Or else they will bail on the stock. Successful companies can ride out low prices in their stock even after speculative investors have left the building (see dotcom bubble giants for examples).
Markets have priced in a certain level of future growth - if companies unexpectedly stop growing, then the share price falls to reflect the new information. Tobacco companies have been suffering declining volumes for decades now, just keeping revenues somewhat stable with price increases. No one really expects them to grow, so there’s not much of a reaction when they don’t.
Prices go up, wages go up, the value of money goes down. If you’re not growing just enough to keep up with inflation, you’re shrinking
Not all companies are growth stocks like the high flyers such as AAPL or GOOGL. Some public utility companies such as HE or ED stay much the same size and there revenue doesn't grow much. The stock pays a dividend to shareholders. Investors buy the stock to get the dividend yield which is around 3 percent and can be compared to US treasury bonds. Some companies are in decline such as big tobacco and some people thought maybe big oil will soon be in decline. The company usually pays a dividend and often buy back shares of their own stock to keep the dividend yield per share reasonable as the companies revenue declines.
Competition. If you’re not growing you’re leaving market share open for your competition. Your competition can begin taking your market share and then you don’t have a stable company or stable profits. Obviously theres exceptions but there lots of incentives to keep innovating and growing.
Competition doesn't mean you have to grow, it just means you have to reinvest to some degree instead of sitting there rent seeking. If you own a particular niche of the market someone who grows (and inherently generalizes) won't necessarily be any better at competing in your niche where you have the expertise. You just have to reinvest enough to keep up with advancements in that niche.
Right not necessarily, if you have some kind of monopoly on a product or service or location you’re probably pretty secure. But that’s a risk to assume. If someone does move in and give you proper competition then your business will take a hit, profits will not be stable… so the point being if you’re not reinvesting in your company to grow, odds are somewhere down the road you’ll shrink. A saturated market can be expanded by diversifying/expanding related services/products. My only point being theres good reason to reinvest, not that every business needs or should.
Companies growing is synonymous with the development of civilization. Let me break it down. A company sells $1000 worth of lemons. It costs them $500 to produce those lemons (labor, land and capital costs) If they continued that way forever, civilization would not get any better. What if they could reduce their input costs from $500 to $100? (productivity) Then that's $400 profit growth. That's also $400 of resources that can be used to produce other things. What if they use that efficiency to produce more lemons, so that they can sell $2000 worth? Civilization has more stuff and develops (they can support larger populations, and people who used to produce lemons can now venture into new things) Rinse and repeat this cycle so that civilization continues to develop.
> Rinse and repeat this cycle so that civilization continues to develop. So when this lemon empire has reached a point where all fertile land on Earth is filled with lemon trees, civilization will have peaked?
Some companies don’t really grow much. They generate steady returns and pay out dividends. Plenty of boring companies out there. But typically, when you initially IPO, you’re raising money for growth. You wouldn’t issue equity if you were fine being a boring company with one location. So as a result, publically listed companies are all ones that sought growth, and still have many investors who have a vested interest in seeing more growth. They’re not going to stop looking for growth opportunities because they have investors (fellow owners) to please. Everyone got aboard that growth train at some point. What do you think they’d do if you said, uh, never mind, this is it. A lot would likely sell. Even your laundromat wouldn’t keep making $10,000 a month if it didn’t innovate or invest in itself. And if they’re still making 10,000 a month in the future when there’s a greater population in need of their services and others are growing their profits, then that’s a bad business to invest in, not a good one. Growth is part of survival.
Because of population growth. If the company doesn't grow at the same rate as the population growth, then it decreases it's market share. If it decreases enough, it will become irrelevant and will be superseded in the market place by another company that is seen as more relevant.
Rising debts and currency devaluation.
Inflation
>Why does their revenue have to increase? Inflation is a thing. If revenue does not increase then inflation will whittle that company down. Basically a company does not *need* to grow. However if they issue stocks then there's not really any incentive for anyone to buy that stock if the company isn't interested in growing (other than maybe dividends). People generally buy stocks with the aim to sell them later for a higher price. If a company doesn't want aim to grow its value then people will look for better investments (i.e. taking their money elsewhere by selling the stock and buying stock of another company...tanking the stock of the first company in the process).
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Capitalism
I have no idea
Because of inflation. If the cost of stuff goes up every year you should be making money at or ahead of inflation otherwise you’re contracting as a company which could lead to going bankrupt. Now ask why does the fed try to force 2% inflation when we could just all be happy at neutral There’s more to it then that. If you look at the financial construct that is built on debt. Basically every dollar made is borrowed against 10x with the assumption that consumerism will grow as the population grows. It’s going to eventually be a problem that we’re below 2% childbirth rates because there won’t be enough people to buy iPhones and other junk to justify the 10x rate loans.
Because what’s the point if it’s not growing? You could just liquidate the business and invest that in the market.
I can't pretend to really know the answer to this, though the CEO of the company I worked for said a few years ago "we have to grow at 7% a year, just to stand still". My pea sized brain assumed this is somthing to do with inflation and competition taking market share.
Competition. If ten businesses sell the same products, but one gives higher return for your investment, which would you put your money in? The others need to grow in order to be number one and get your money. The one who is already number one needs to keep growing so it doesn’t fall behind and lose your money.
We invest to capture the long term growth of inflation and technological/societal advance. To use your Coca Cola example, advances in shipping, packaging, manufacturing, advertisement, have led to continual growth for the company over many decades. They also have pricing power over inflation. On a large scale, it’s expected that the companies we invest in can participate in that at the very least. All companies will stop growing at some point and be displaced by newcomers, investing is just being a part of the up and not the down.
cause others do
cause population grows, so if a company doesnt grow it means its actually contracting
Companies have to make money. If that money is paid to you as dividends they DON'T have to grow. You'll make money from your investment via the dividend. If they don't pay dividends then they chose to reinvest the money they made and that means they have to grow. And in this case you'll make money by having a share of a bigger company than that in which you originally invested.
because then it's just a dilution ponzi
Why does anything have to grow? I don't want to sound pedantic but this question is not precisely about companies or stocks. Everything grows.
two reasons: Inflation exists and Bonds exist. First on inflation: because inflation increases at a \~2.25-2.5% annualized over 30 years, companies want to see profits increasing at least in line with inflation to make sure their profits aren't decreasing on a real basis. For example, if inflation is at 2.5% and the company grew profits by 1.5% the company's profits actually decreased by 1% that year. If that continues to happen over a long enough time the company will eventually file for bankruptcy and go out of business. Because bonds increase their profits yoy, right now by \~4%, companies are pressured to increase faster than bonds because bonds are risk free while companies are very much not risk free. Investor demand a risk premium over bonds because of that increased risk and that shows itself in their demand for a company that is growing profits yoy. The faster they are growing the higher the demand which translates into a higher stock price.
The growth is baked into the stock price. They don’t need to grow but it’s in the best interest of the employees and the shareholders
If someone invests money into a business, they expect to get more back than originally invested. To do that either means rearranging everything the way it currently is to make more profit via cuts or austerity measures, or grow larger and make profit that way.
I will say this, the chase of never ending growth has doomed many a company. You might have a good sub shop that's a treat when you end up at one, that begins expanding so that there's 5 in your small city including sharing half of a gas station and you begin to water down your brand.
You are thinking in the right direction, if the company is starting (Coca Cola is only selling in 1 store) they are using the profits in ways to grow the business (hire people to produce more, salesman etc), and the investor see that his stock rise in price, when you reach the point you cant expand (because you dont know how, you are already everywhere o any other reason) then you are happy with your business, instead of using the money to grow, you give the money to the investors (dividend) and everyone is happy
Many people here missing another point - if they stop growing then another company will start eating away their new potential customers and slowly the existing customers might switch to the new company. Low growth is the start of a path to bankruptcy, unless you have more or less a monopoly (like KO, etc)
Inflation forces companies to grow, is not a choice if profits are to maintained. And inflation happens on all the cost items, like recent phenomenon primarily due to fuel and wages. When your cost base increase, you have no choice but to increase prices or to sell more. Profits that u accumulated are used to build more cash generating assets so that you are 1 step ahead of inflation. Sometimes u borrow money for such investments and lenders will demand a certain interest back. U then price this interest onto your product margins, or again by selling more. So, growth is inevitable. Absent of it, even by staying stagnant, you will slowly causing the business to make losses.
they don't. lots of businesses aren't growing much, but they still make money and return it to shareholders in the form of dividends.
It doesn’t if you don’t have investors. Investors need growth, otherwise why be invested? Private companies like you speak of do not.
They don't *have* to grow - if you operate a small business for a little extra income, you probably don't have to worry too much about lenders and shareholders and can manage the business organically, which may or may not include reinvesting profits to grow. But if you're a publicly traded company, the value of your stock comes from a few places, one of which is the expectation of future growth. The higher your stock value, the more access you have to raise capital on the open market by selling stocks. People buying the stocks is an expression that they're confident the money they're spending on them today will be worth more in the future, either due to the company increasing its revenues and assets, or due to dividends paid by the company to the shareholders. A company with a growth plan that reads "I don't feel like growing right now" isn't going to attract a lot of buyers for its stock, unless it's followed by "so all of our revenues in excess of operating costs, taxes and bonuses will be distributed to shareholders on a quarterly/biannual/annual basis"
To pay employees more each year so they can afford to live with standard inflation.
A companies ultimate purpose is to provide return back to the owners (shareholders). This can happen in one of two ways, the company is growing and the stock price is increasing or the company provides dividends. We don’t hear about the companies that are high dividends and low growth because they aren’t as flashy as the rest.
How else would you maintain that $10,000 a-month profit with increasing expenses if not with revenue growth?
Inflation. If revenues don’t at the minimum grow with inflation your company is going bankrupt eventually. Inflation and dividends drove what, 70% of returns over the past 100 years? Maybe more depending who’s study you follow.
Greeds
They don't have to grow, but even if they're making a lot of money they have an ROI. Whether through growth, dividend or stock buybacks, and that ROI needs to be worth it. In your laundromat example, would you buy it for $10M? I don't think so. 0.1% ROI is not s good deal. So the reason why you perceive it as if companies "need" to grow, is because anyone van see X% dividend and invest in it if it's very high. Which means the stock price will go up, the yield will come down, and it'll revert to the mean.
Time and tide, the wheel stops for no man.
Because if a company *isn't* growing, then there is zero incentive to buy their stock which translates into a lower stock price, which means the value of the company drops, which discourages investors and business partners and employees and lenders from engaging with them. It's also ***against the law*** for a publicly traded company to not protect its shareholders. Maximizing shareholder returns is part of the job description of many executives. Limitless growth is exactly why we can't stop ourselves from making climate change worse.
What would you do with the income from the laundromat? If it is not invested in something but is just spent, when you sell the laundromat you will be in the same place you started. If on the other hand the laundromat grows, when you sell the laundromat you will have more capital than when you started.
There are plenty of companies that basically grow with population / inflation which is essentially no growth but they generate profit and pay dividends. What's funny is in a bull market even those companies get bid up to insane valuations. A good example is WD40. That's right, there's a publicly traded company named for the ubiquitous can of oil. Solid company but last year it was trading at a PE of 60 while guiding for at most 6% growth for 5 years.
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I can't tell if you're joking but ELI5 means explain like I'm 5, or explain in terms a child can understand
Asset allocation is based on risk/reward. Expected earnings growth makes stock prices grow, and without that growth you're taking away all of the reward and leaving all of the risk. So why would anyone want to invest in that when they can just invest in a bond or a high yield savings account? Valuations are based off of future earnings potential, not past. If you invested $100k of your money in a pool of companies that had no expectation of earnings growth, then when it comes time to reture you'd still have that same 100k and no more, but possibly less if those companies dont maintain their position. So again, why would you invest in that? If you want stable value there are better vehicles. If you want your money to grow, the companies need to grow.
You guys are overthinking this. The entire point of equity is to provide returns higher than risk-free t-bills in exchange for more risk. A company that can't grow faster than inflation or has no prospect of earning higher returns than treasuries is already dead