Revenue and earnings growth

Bigger every year

This year Sunny Slice's revenue is $10 million. Next year it's $11.5 million. How fast did it grow?

Growth = (new minus old) ÷ old = ($11.5M minus $10M) ÷ $10M = 0.15, or 15%.

Now meet Slow Steady Soup. It also has $10 million of revenue, but it grows only 3% a year.

After five years, Sunny Slice is at about $20 million. It doubled. Soup is at about $11.6 million. Remember the rule of 72 from Money Basics? 72 ÷ 15 is about 5, so growing 15% a year doubles in about 5 years.

Where growth comes from

1. New shops. Sunny Slice goes from 20 shops to 40.
2. More sales at the old shops. This is called same-store sales. Investors love it, because selling more at a shop you already have is cheap. A new shop costs a lot to open.
3. Higher prices. A $12 pizza becomes $13. Careful: raise prices too much and customers leave.
4. New things to sell. A delivery app, wings, frozen pizza in grocery stores.

Profit can grow faster than sales

Some costs don't grow when sales grow. Sunny Slice's head office (the boss, the accountants, the website) costs about the same with 20 shops or 40. So when revenue doubles, profit can more than double.

In our story, revenue doubles from $10 million to $20 million over five years, and profit grows from $1.5 million to about $3.5 million. Earnings per share go from $1.50 to $3.50.

If investors keep paying the same 20 dollars for each dollar of profit (you'll learn why in the next lesson), the price goes from $30 to $70. That's the engine: growing profit pulls the price up over time.

Growth stocks and value stocks

• Growth stocks are companies growing fast. Investors pay a lot for them, hoping for big profits later. They often pay no dividend.
• Value stocks are slower companies that look cheap compared to what they earn. They often pay dividends.

Neither always wins. In some stretches of history growth stocks did better, and in others value stocks did.

What goes wrong

• Growth slows down. Growing 15% a year is easier with 20 shops than with 2,000. When growth slows, a growth stock's price can fall hard, even though the company is still growing.
• Growth that loses money. Opening shops that never make a profit is just a fancy way to burn cash.
• Growth paid for with debt. Borrowing a lot to grow fast can turn into big trouble if sales dip.
• Expectations. If everyone expects 30% growth and the company delivers 20%, the stock can drop. You saw this in the earnings lesson: it's always compared to what people expected.

Remember

• Growth = (new minus old) ÷ old.
• Growth comes from new shops, more sales per shop, higher prices and new products.
• Over years, growing profit is the engine that pulls a stock up.
• Fast growth always slows someday, and the price can fall when it does.