A successful company typically passes through several growth phases. The Startup Phase is when earnings are below the break-even point (the company is losing money). Explosive Growth is when the percentage increase in sales and earnings tends to be spectacular, often approaching or exceeding 20% annually. SmallCap Informer typically spotlights companies in this phase. The Mature Growth period is when revenue becomes so large that it is difficult to maintain consistent growth rates. And when companies do not continue to rejuvenate their product mix and fail to expand their target markets, they can go into a period of Stabilization or Decline.
Investors using the BetterInvesting approach focus on companies that are into their explosive growth period and are not yet past their primes. Small and midsized companies typically are entering their explosive growth phases.
What kind of growth rates do successful companies have? It depends in large part on the size of the company. Expected growth rates from typical companies vary from a low of about 7% for large companies to a high of around 20%. If a company is well established and has annual sales above $5 billion, a growth rate of as little as 7% is acceptable. The stock's yield in such cases should provide an additional component of return. Some additional return should come from expanding P/E ratios (from the practice of buying the stock when it is cheap relative to its historical valuation levels and future expected growth).
Newer companies in the explosive growth period should show double-digit growth. Companies profiled in SmallCap Informer belong to this category. Growth rates above 20% cannot be sustained forever, but higher growth rates are some compensation for the increased associated risk of investing in these smaller businesses.
In our stock studies, we often project growth at rates below maximum expected results to modulate enthusiasm. By being conservative in this fashion we attempt to limit surprises to those of the upside variety. If a company's growth fails to meet our expectations, we will likely be disappointed in the stock's performance, but if a company exceeds our growth projects we will be pleased with the results.