Growth – for very many private investors it is the watchword when it comes to picking stocks and turning a profit. Yet while the essence of backing companies that are growing seems apparently very obvious on the surface, the realities of how and why a business is growing – and how that might impact on an investment – can quickly muddy the waters.

In a speech at the recent Growth Company Investor Show, Michael Crawford, the Principal Fund Manager of the UK Growth Fund at LV= Asset Management, outlined his interpretation of what growth means when it comes to value and what investors should be looking for when it comes to backing companies. His main message was that investors need to keep a keen eye on the potentially negative effects of a company’s asset growth when weighing up the revenue and profit potential.

So what does growth actually mean in the context of investing in companies? According to Crawford it is a generic term with many different meanings. First, there is industry level growth, such as the technology boom that triggered surging revenues in certain parts of the industry. Next, there is company revenue growth – or increasing sales. That is distinct from profits growth, where companies can influence their figures by making efficiency savings without the need for fast revenue improvements. Then there is growth in free cash flow, which can occur even with very static profit growth. Finally, there is asset based growth, where companies invest in new factories and new plant.

The fund manager explained: “I want to use an example to explain that not all growth is good. Take Company A, which earns £10 on an asset base of £100, so basically it earns a 10% return on capital. Now this company might say ‘I’ve got earnings growth of 20% this year’, which everyone gets quite excited about and thinks is very good. But actually it has grown its asset base by 30%. In other words, it’s a bit like if you put £100 in your bank and then put £30 more into that account, you’re only going to increase your interest return by 20% and that, actually, is not very good. In fact, the new return on capital is only 9%.

“If we then look at another company, Company B, with very similar characteristics,…

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