Outstanding Growth: Why It Cannot Last - John A Robertson

Click here to buy - A How To Book of SMSF's by Tony Negline

John A Robertson

Outstanding growth cannot last forever. Equity markets often overlook this seemingly obvious warning but not indefinitely. Flight Centre is another topical example and a good illustration of this bigger picture.

During the past two years, the share price of listed airline ticket retailer Flight Centre has fallen by 50% after rising by a factor of 15 during the 1990s.

The specifics of Flight Centre (and whether it should be bought or sold now) are less important than the bigger picture of a company unable to sustain the super-normal growth rates which the market had once been convinced it could deliver. These comments are not intended to suggest anything about the investment attractiveness of Flight Centre at current prices.

There are at least six reasons why super-normal growth is hard to sustain.

As a company gets bigger, high rates of growth simply become mathematically more difficult to achieve.
A company depends on its immediate business environment for its customers. Their level of demand will ultimately determine its growth.
Since some of the growth from high flyers ultimately comes from acquisitions of other companies, the dwindling number of remaining former competitors upon which acquired growth depends inevitably declines.
As the company gets bigger, acquisitions have to be proportionally larger or more frequent to be as meaningful, creating added execution risk for managers.
To the extent that one-off cost initiatives or new ways of doing business are at the heart of high rates of profit growth, the impact on profit growth will diminish.
Size and success sometimes also attract copy-cats eventually taking the edge from early-mover status.

Flight Centre is suffering most of these tendencies. As with other companies, there will also be more specific circumstances. In this case, the travel market has been afflicted by high oil prices and there are continual reminders of the dangers of international travel.

The combination of these influences tends to bring growth back to the norm eventually. Ultimately, the macroeconomic environment and management limitations tend to assert itself and, over time, the pace of growth will tend to fade.

Sustaining the all-important rate of return for a high-growth company is also a challenge. Analysis by thebigpicture Economics shows that relatively high rates of return underpin relatively high share prices. Flight Centre had once been an excellent example of a company with abnormal growth and a high rate of return on the funds employed in the business.

The emergence of slowing growth and a declining return - the Flight Centre predicament highlighted in the accompanying chart - is akin to removing two legs from an equity market tripod and is another reminder of the importance of this combination in making equity portfolio choices.

Share this article

Previous article Next article

This email is general in nature only and does not constitute or convey specific or professional advice. Legislation changes may occur quickly. Formal advice should be sought before acting in any of the areas discussed. Be aware that the information in these articles may become innaccurate with time. Responsibility is disclaimed for any inaccuracies, errors or omissions. Particular investments are neither invited nor recommended and hence this publication is not "financial product advice" as defined in Section 766B of the above legislation. All expressions of opinion by contributors are published on the basis that they are not to be regarded as expressing the official opinion of any other person or entity unless expressly stated. No responsibility for the accuracy of the opinions or information contained in the contributor's articles is accepted by any other person or entity. Copyright: This publication is copyright. If you wish to reproduce this article you require a license, which can be purchased here, to do so.