Table of contents
Disclaimer: This communication is provided for information purposes only and is not intended as a recommendation or a solicitation to buy, sell or hold any investment product. Readers are solely responsible for their own investment decisions.
Rule of thumb:
The company’s projected revenue growth in the future should be exceeding your required rate of returns.
For example, if your annual required rate of return is 15% for the next 10 years
and the company’s projected revenue growth rate is 20% in the same duration, this will be an attractive company.
Checking the company’s past revenue trend:
Fortinet’s revenue has been increasing quite high, > 25% in past 5 years. Which is more than the 15% annual required rate of return.
IBM, on the other hand, is experiencing very slow amount of growth in the past few years
Although IBM has one of the top-rated cybersecurity products,
I line growth to the company because it is likely only one out of the hundreds of products and services they offer.
Companies with slow revenue growth have higher risk of being overvalued.
In situations when the stock price growth consistently exceeds its revenue growth, the company will eventually become overvalued (read more on valuation & price to sale ratio).
The next question to ask is:
How likely is the company going to sustain this growth rate for the foreseeable future?
This will be tied to product ratings of the companies.
Companies with satisfied customers will have higher chances of maintaining high sales growth rates.
And also the growth rate and cap of the industry they are operating in,
which should give you a realistic idea on how long they are able to sustain this revenue growth rate.
Does this mean that you should not invest in companies with slow revenue growth rate at all?
Not necessarily, personally my required annual returns to hit my financial goals is 15 - 21.5% for the next few decades.
Although there is low probability that Apple (NASDAQ: AAPL) is able to sustain a revenue growth above that figure for the same duration of time because of their already large revenue baseline.
I am still a fan the stock because of other favorable aspects of the company which are very difficult to be duplicated by others, such as their:
Superior branding power
High switching costs for customers (with very long customer lifetime value, probably one of the highest in the world.)
(read more on Apple here:
Hence I am still keen to own some of the stocks in my portfolio at a minority stake.
As long as the projected revenue growth for majority of the companies in my portfolio are still expected to exceed my required annual returns, the math will still work out.
To learn about how many stocks you need in your portfolio, read https://www.maximizations.com/post/how-many-stocks-do-you-need-to-build-a-diversified-portfolio)
Conclusion:
Investors (particularly growth investors) should avoid investing majority of their portfolio in companies with slow revenue growth.
Companies with slow revenue growth are less likely to see their stock prices increase over time, and may even see them decline over time.
Looking for a set of checklists to identify great companies for your portfolio?
