Terry Pullen, CEO, Greenbank Capital
It is the million-dollar question. How does one identify companies with the potential for explosive, global growth that nevertheless remain undervalued in a world where access to information and the speed of communication has never been greater? How does one unearth these gems?
Of course, there is no simple formula, but in a world emerging from a pandemic, with decent economic growth, moderate inflation, and gradually rising interest rates, there is still a case to be made for growth investing over value investing. A careful consideration of some fundamental company attributes can give one the highest chance of success.
Scalability
Scalable is a word that gets thrown around a lot in the business world, but what does it mean? Scalability describes a company’s ability to grow without being hampered by its structure or available resources when faced with increased production. If increased revenues cost less to deliver than current revenues, then the cost of growing is outweighed by the resulting profits, and a business is deemed scalable.
Businesses with the greatest potential for growth have the greatest need for scalability as they must continue to meet ever changing market demands that accompany growth. Unsurprisingly, scalability and technology often go hand in hand and are inseparable for an efficient transition during growth. We’re familiar with digital companies such as Facebook and Spotify that scaled rapidly as their users expanded, but technology also eases the process of scaling a business in any industry.
Tech-savvy, digital businesses often keep little or no inventory, while many of them also utilize the Software as a Service (SaaS) approach to dealing with stock. Evidence of this kind of scalability is furthermore often a sign of competitiveness because it means a business can handle increased demand, trends, and needs, even with the emergence of new competitors.
The value of leadership
They say a company is only as good as its people, and an experienced, innovative management team is vital for a growth company with global ambitions. 80% of successful innovative companies have top leaders who reinforce the value and importance of innovation, so carefully reviewing a company’s management team before making a growth investment is therefore a critical first step. An investor needs to be sure management can motivate and inspire their staff, communicate the company vision, and, most importantly, ensure that this vision can be executed on the ground.
A large market in which to grow
A company with the potential for exponential growth must operate within a market that is either itself growing or poised for growth. Furthermore, this must be a potentially large market, not one that cates to a niche product or segment.
Yet, operating in a high growth industry alone isn’t enough. A company must be able to command a sufficient share of the market so that it isn’t playing second, third, or fourth fiddle to the companies that will come to define the industry.
Equally, companies will need to be able to sustain their competitive advantage. Companies that rely on a single product should be avoided with preference given to those that are adaptable and can develop multiple innovative, successful products and services.
Demonstrable sales growth
While fast-growing earnings is a very positive sign, some young companies will still be investing their cash resources in building up their tech or refining their services. This does not mean the company is uninvestable, but it probably requires thorough due diligence to be sure that the company’s concept is sound and its business model robust.
If a company does have an acceleration in earnings and revenue growth for consecutive quarters, then is a very promising sign. The faster the growth rate, the more attractive the company will be to investors who will help boost that growth even further. There is no set rule as to what that growth rate should be, but high double-digit growth is often seen as a low benchmark.
In fact, many growth companies see triple-digit growth rates in the beginning with this slowing as the market matures. Therefore, double-digit sustained growth a few years down the line of market entry may indicate that room for further growth is limited. An investor should therefore look out for high sales growth following a new management strategy or at the onset of a market breakthrough.
Be alert for sky high valuations
If all the above factors are present, then it is important to avoid overvalued companies, whether that is because there has already been a rush of investor demand or because fundamentals declined while valuation remained constant. Key valuation ratios such as price-to-sales (P/S) and price-to-earnings (P/E) can be an easy way to take an initial view.
A reasonable P/S ratio with the expectation for high sales growth can be a good sign, while a forward P/E that is below the historical average can also mean that the company is undervalued. For a growth stock, revenue growth is more important than earnings growth as long as the company makes efforts to get on the path to profitability. As a company becomes more mature, net income become more important.
Supporting the companies set to define the future
It is important to remember every growth company is different – continuous vigilance is needed to assess risks and remain aware of how the market is changing. This is how we operate at GreenBank Capital, and we consider ourselves experts at identifying undervalued growth companies using our international network of contacts to find and invest in the global businesses set to dominate the future.
In addition to investing in these companies, we also provide them with valuable merchant banking support and expert capital markets advice whether they are looking to list publicly or have already embarked on that journey. The post-pandemic world is ripe with opportunity, it is vital we find and nurture those companies that are grasping these opportunities with both hands.
By Terry Pullen, CEO, Greenbank Capital.
