Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 77

There’s growth, and then there’s growth

If it looks like a duck and quacks like a duck, is it necessarily a duck? That’s the mindset that is sometimes required to fully understand the numbers that are being reported by companies in Australia and around the world at this time of year.

One of the first numbers examined by investors and analysts when a company reports its results is revenue. And more specifically, most are interested in the growth in revenue from, say, one year prior. A company that is growing revenues strongly is more likely to be growing earnings strongly, and therefore more likely to be growing its dividends to shareholders strongly. Furthermore, revenue growth is considered to be a relatively clean metric in that it is independent of the company’s cost structure and is typically untainted by management’s accounting policies.

But not all revenue growth is created equal. And investors and analysts need to carefully dissect the nature of the revenue growth.

Consider a retailer that owns a number of stores. While revenue growth in each store might be weak, the company can boost its headline revenue growth number by opening new stores. We observed this at JB Hi-Fi (ASX: JBH) which reported full-year 2014 revenue growth of 5.3% per annum. Yet on a store like-for-like basis, revenue only grew by 2.0% per annum over the same period.

Similar to the idea of opening new stores is the idea of acquiring new businesses to boost headline revenue growth. This is the strategy of childcare and education provider G8 Education (ASX: GEM). The company recently reported revenue growth of a whopping 59% per annum for the half-year ending 30 June 2014. Most of this has stemmed from the acquisition of additional learning centers. This can be clearly observed in G8’s cash flow statement: payments for the purchase of businesses were $218 million in the six-month period to 30 June 2014. These are significant cash investments given reported revenues in the same period were $187 million.

Sometimes companies can simply benefit from fortuitous macroeconomic tailwinds that serve to inflate revenue growth. A company that has operations offshore with revenues denominated in other currencies will typically go through periods of tailwind and headwind as the foreign currency strengthens or weakens relative to the currency in which the company’s financial results are reported.

The Australian medical device manufacturer and distributor, ResMed (ASX: RMD), has benefited from exactly this dynamic over recent quarters. While the company reports in US dollars, it sells its devices in many countries around the world, in particular those in the Eurozone. Over the last five quarters, the strength in the Euro relative to the US dollar has added around 2-4% in additional revenue growth from ResMed’s international businesses.

Finally, investors and analysts need to be cognisant of the accounting rules around consolidation when examining revenue growth. If company A owns 49% of company B, then company A will typically report no revenue for company B and instead report just its 49% share of company B’s earnings on its income statement. Yet if company A were to increase its ownership to, say, 51%, then all of company B’s revenues would be reported on company A’s income statement under the rules of consolidation. The perceived growth in reported revenue can be substantial, simply by increasing ownership in an associate company to a level above the 50% threshold. This quirk in the accounting rules has certainly been a contributing factor to the very strong reported revenue growth of online employment advertiser, Seek (ASX: SEK). Seek owns a portfolio of interests in online employment portals around the world and has slowly increased its ownership in these associate companies over the years. As Seek’s ownership level in each associate crossed the 50% threshold, it was required to consolidate 100% of the associate’s revenues into its own income statement, providing a substantial tailwind to its reported revenue growth.

There is nothing inherently right or wrong with each of the examples described above. They simply reflect different versions of the same thing: reported revenue growth. Each has different implications, however, and investors and analysts need to consider these carefully. Perhaps the most important consideration is around the sustainability of the revenue growth that is reported. Understanding the underlying drivers of revenue growth serves to inform this assessment of sustainability for the investor or analyst.

Finally, investors and analysts should be cautious of very high rates of reported revenue growth. It is not that high rates are inherently unsustainable, it is just that they cannot exist in aggregate across the corporate sector. Roughly speaking, the growth in aggregate corporate revenues should be roughly equal to the GDP growth of the economy. So if a company or a sector is growing at rates well above this level, one needs to believe that there are other companies or sectors growing at rates well below this level.

 

Andrew Macken is a Senior Analyst at Montgomery Investment Management.

 

  •   29 August 2014
  •      
  •   

 

Leave a Comment:

banner

Most viewed in recent weeks

Why have Australian living standards 'fallen' and how do we fix it?

For the last few years there has been much talk of a 'cost-of-living' crisis in Australia and of 'falling living standards'. Lately this has flared up again with the pickup in inflation resulting in a renewed fall in real wages.

Will you run out of money in retirement?

Fear of running out has become a defining retirement anxiety. Why do some retirees die with substantial wealth while others deplete their nest egg? Evidence suggests the answer is more complicated than we think. 

Four options for an income investor’s next dollar

What if Australia’s golden age of dividends is ending? Rather than overhaul your portfolio, it may be worth considering where new capital can work harder. I discuss four income strategies and the trade-offs behind each.

Why spending more in early retirement can improve lifetime income

Conventional wisdom encourages retirees to preserve superannuation. But if those likely to qualify for the Age Pension later in life spend a little more today, it may deliver higher lifetime income and a more stable retirement.

The investment that sidesteps the new tax traps

Tax rules have changed, but many investors are still using yesterday’s strategies. Insurance bonds may offer advantages for those seeking greater control, tax efficiency and certainty about their wealth.

Testamentary trusts have secured the CGT exemption

Treasury’s latest CGT reform draft delivers a win for testamentary trusts and deceased estates, exempting estate-derived gains from the 30% floor. However, questions on death and divorce rollovers remain unresolved.

Latest Updates

Shares

Is it time to bail on Australian stocks?

For generations, Australian investors have backed banks, miners and dividends. But has that loyalty come at a cost? A look at the numbers raises an uncomfortable question about where future returns will come from.

Investment strategies

Making a case for the 40 year mortgage

The housing debate tends to focus on prices, interest rates and deposits. Yet an overlooked feature of the mortgage itself could help buyers enter the market sooner without abandoning prudent lending standards.

SMSF strategies

Red flags to watch out for when considering an SMSF

Thinking about an SMSF? Before you sign anything, learn how to spot the difference between genuine advice and a sales pitch, understand the real costs, and avoid the compliance mistakes that attract ATO attention.

Investment strategies

Not all income is created equal

Market conditions are shifting as familiar yield sources quietly lose momentum. Australian public credit may be the most compelling source of income in today's market but many investors haven't noticed the shift. 

Investment strategies

The market paid for change, not comfort

Reporting season has delivered a clear message: the market is no longer paying simply for quality, resilience or an earnings beat. It is paying for change in earnings expectations and the outlook ahead. 

Investment strategies

Will AI destroy investor capital?

Some of history's most important innovations changed the world while leaving investors much poorer. As trillions pour into AI, a familiar pattern may be emerging, one that rewards society far more generously than capital.

ASX reporting season: Signals, surprises, stock stories

August reporting season delivered strong earnings and bigger-than-expected dividends, but beneath this, a more nuanced story emerged. First Sentier Investors’ David Wilson and Christian Guerra unpack the key trends.

Sponsors

Alliances

  • ASA-Logo-RGB-ActiveGreen-web.png

© 2026 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.