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.

 


 

Leave a Comment:

banner

Most viewed in recent weeks

Australian house prices close in on world record

Sydney is set to become the world’s most expensive city for housing over the next 12 months, a new report shows. Our other major cities aren’t far behind unless there are major changes to improve housing affordability.

The case for the $3 million super tax

The Government's proposed tax has copped a lot of flack though I think it's a reasonable approach to improve the long-term sustainability of superannuation and the retirement income system. Here’s why.

7 examples of how the new super tax will be calculated

You've no doubt heard about Division 296. These case studies show what people at various levels above the $3 million threshold might need to pay the ATO, with examples ranging from under $500 to more than $35,000.

The revolt against Baby Boomer wealth

The $3m super tax could be put down to the Government needing money and the wealthy being easy targets. It’s deeper than that though and this looks at the factors behind the policy and why more taxes on the wealthy are coming.

Meg on SMSFs: Withdrawing assets ahead of the $3m super tax

The super tax has caused an almighty scuffle, but for SMSFs impacted by the proposed tax, a big question remains: what should they do now? Here are ideas for those wanting to withdraw money from their SMSF.

The super tax and the defined benefits scandal

Australia's superannuation inequities date back to poor decisions made by Parliament two decades ago. If super for the wealthy needs resetting, so too does the defined benefits schemes for our public servants.

Latest Updates

Planning

Will young Australians be better off than their parents?

For much of Australia’s history, each new generation has been better off than the last: better jobs and incomes as well as improved living standards. A new report assesses whether this time may be different.

Superannuation

The rubbery numbers behind super tax concessions

In selling the super tax, Labor has repeated Treasury claims of there being $50 billion in super tax concessions annually, mostly flowing to high-income earners. This figure is vastly overstated.

Investment strategies

A steady road to getting rich

The latest lists of Australia’s wealthiest individuals show that while overall wealth has continued to rise, gains by individuals haven't been uniform. Many might have been better off adopting a simpler investment strategy.

Economy

Would a corporate tax cut boost productivity in Australia?

As inflation eases, the Albanese government is switching its focus to lifting Australia’s sluggish productivity. Can corporate tax cuts reboot growth - or are we chasing a theory that doesn’t quite work here?

Are V-shaped market recoveries becoming more frequent?

April’s sharp rebound may feel familiar, but are V-shaped recoveries really more common in the post-COVID world? A look at market history suggests otherwise and hints that a common bias might be skewing perceptions.

Investment strategies

Asset allocation in a world of riskier developed markets

Old distinctions between developed and emerging market bonds no longer hold true. At a time where true diversification matters more than ever, this has big ramifications for the way that portfolios should be constructed.

Investment strategies

Top 5 investment reads

As the July school holiday break nears, here are some investment classics to put onto your reading list. The books offer lessons in investment strategy, financial disasters, and mergers and acquisitions.

Sponsors

Alliances

© 2025 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.