Growth and shareholder valueFebruary 4, 2019
Simply puffing up your business will not create shareholder value.
Lots of business owners I meet are chasing growth – they want to be a bigger business, have more staff, more clients, more sales, bigger office, and so on.
They want growth, but many don’t appreciate this can be poisonous or value destructive.
Almost every business acquisition announced by a public company CEO will state that the acquisition will be earnings accretive. In other words, profit will increase per share.
By way of random example, Shine Corporate (you know, the one with Erin Brokovich) announced on January 4 2019 that it will acquire a family law practice for $3.6 million. In the announcement, there is a statement “The acquisition is expected to be earnings accretive in FY19”.
Increasing sales or profit does not always translate to increasing shareholder value, despite what the public company announcements tell us.
Profitable growth requires investments in working capital (debtors, stock, creditors), new staff, equipment, or all of these things.
An increase or investment in working capital, staff or equipment uses cash.
If the investment (cash) required is greater than the profit generated, then value may not be created, at least not in the short term.
Value creation is best measured by understanding returns to the business owner (shareholder), consisting of both:
- The change in the value of the business
- The operating cash generated and available for distribution.
If we estimate the returns, we can work out whether growth making business decisions are puffery or truly adding shareholder value.
We can also compare the returns on our business (an investment) with returns on other assets such as shares and property.
Thanks for reading.