Growth fixes a multitude of sins. If a company grows revenues enough (you don't even need profits, as Amazon has proven) investors will look past a lot of things. With revenue growth high enough, companies can offer employees free meals and massages. Executives and senior managers can fly around in private jets. Companies can build colossal buildings as testaments to their brand, or pay to have their names on public buildings. R&D budgets can soar, and product launches can fail. Acquisitions are made with no concern for price. Bonuses can be huge. All is acceptable if revenues grow enough.
Just look at Facebook. Today Facebook announced that for the quarter ended March, 2016 revenues jumped to $5.4 billion from $3.5 billion a year ago. Net income tripled to $1.5 billion from $500 million. And the company is basically making all its revenue -- 82% -- from one product, mobile ads. In the last few years Facebook paid enormous premiums to buy WhatsApp and Instagram -- but who cares when revenues grow this fast.
Anticipating good news, Facebook's stock was up a touch today. But once the news came out, after-hours traders pumped the stock to over $118/share, a new all-time high. That's a price/earnings (p/e) multiple of something like 84. With growth like that Facebook's leadership can do anything it wants.
But, when revenues slide the world can seem a veritable poop puddle. As Apple found out.
Rumors had swirled that Apple was going to say sales were down. And the stock had struggled to make gains from lows earlier in 2016. When CEO Tim Cook announced Tuesday that sales were down 13% versus a year ago the stock cratered after-hours, and opened this morning down 10%. Breaking a streak of 51 straight quarters of revenue growth (since 2003) really sent investors fleeing. From trading around $105/share the last four days, Apple closed today at about $97. $40 billion of equity value was wiped out in one day, and the stock trades at a p/e multiple of 10.
The new iPhone 6se outsold projections, and iPads beat expectations. First year Apple Watch sales exceeded first year iPhone sales. Mac sales remain much stronger than any other PC manufacturer. Apple iBeacons and Apple Pay continue their march as major technologies in the IoT (Internet of Things) market. And Apple TV keeps growing. There are over 13M subscribers to Apple Music. There are 1.5 million apps on the iTunes store. And the installed base keeps the iTunes store growing. Share buybacks will grow, and the dividend was increased yet again. But, none of that mattered when people heard sales growth had stopped. Now many investors don't think Apple's leadership can do anything right.
Yet, that was just one quarter. Many companies bounce back from a bad quarter. There is no statistical evidence that one bad quarter is predictive of the next. But we do know that if sales decline versus a year ago for two consecutive quarters that is a Growth Stall. And companies that hit a Growth Stall rarely (93% of the time) find a consistent growth path ever again. Regardless of the explanations, Growth Stalls are remarkable predictors of companies that are developing a gap between their offerings, and the marketplace.
Growth Stalls Are Deadly, As We See At Chipotle
Chipotle announced that same store sales fell almost 30% in Q1, 2016. That was after a 15% decline in Q4, 2015. And profits turned to losses for the quarter. That is a Growth Stall. Chipotle shares were $750/share back in early October. Now they are $417 -- a drop of over 44%.
Customer illnesses have pointed to a company that grew fast, but apparently didn't have its act together for safe sourcing of local ingredients, and safe food handling by employees. What seemed like a tactical problem has plagued the company, as more customers became ill in March.
Whether that is all that's wrong at Chipotle is less clear, however. There is a lot more competition in the fast casual segment than three years ago when Chipotle seemed unable to do anything wrong. And although the company stresses healthy food, the calorie count on most portions would add pounds to anyone other than an athlete or construction worker -- not exactly in line with current trends toward dieting. What frequently looks like a single problem when a company's sales dip often turns out to have multiple origins, and regaining growth is nearly always a lot more difficult than leadership expects.
Growth Is Magical
It allows companies to invest in new products and services, and buoy's a stock's value enhancing acquisition ability. It allows for experimentation into new markets, and discovering other growth avenues. But lack of growth is a vital predictor of future performance. Companies without growth find themselves cost cutting and taking actions which often cause valuations to decline. And few recognize the need for serious changes in their success formula in order to realign with market trends.
Right now Facebook is in a wonderful position. Apple has investors rightly concerned. For the app pioneer, will next quarter signal a return to growth, or a Growth Stall? And Chipotle has investors heading for the exits, as there is now ample reason to question whether the company will recover its luster of yore.
Learn more at AdamHartung.com, or connect with me on LinkedIn, Facebook and Twitter.
Links To More Info:
The brilliance of Facebook's WhatsApp acquisition
2014 prediction - why Facebook is the 1 stock to own
Why growth is all that matters for Apple - and Tim Cook can't tell a story
Apple is defending & extending its base - but will that create growth, or please investors?
