Thequestionofhowlongafirmwillbeabletosustainhigh
growth is perhaps one of the more difficult questions to
answerinavaluation,buttwopointsareworthmaking.One
isthatitisnotaquestionofwhetherbutwhenfirmshitthe
stablegrowthwall.Allfirmsultimatelybecomestablegrowth
firms, in thebestcase,because high growthmakesa firm
largerandthefirm’ssizewilleventuallybecomeabarrierto
furtherhighgrowth.Intheworst-casescenario,firmsmaynot
surviveandwillbeliquidated.Thesecondpointisthathigh
growth in valuation, or at least high growth that creates value,
1 comesfromfirmsearningexcessreturnsontheirmarginal
investments. In other words, increased value comes from
firmshavingareturnoncapitalthatisinexcessofthecostof
capital(orareturnonequitythatexceedsthecostofequity).
Thus, when you assume that a firm will experience high
growth forthenext 5 or 10 years, you arealso implicitly
assumingthatitwillearnexcessreturns(overandabovethe
requiredreturn)duringthatperiod.Inacompetitivemarket,
theseexcessreturnswilleventuallydrawinnewcompetitors
and the excess returns will disappear.
Weshouldlookatthreefactorswhenconsideringhowlonga
firm will be able to maintain high growth.
1.Sizeofthefirm.Smallerfirmsaremuchmorelikelyto
earnexcess returns and maintain theseexcess returns than
otherwisesimilarlargerfirms.Thisisbecausetheyhavemore
roomtogrowandalargerpotentialmarket.Smallfirmsin
largemarketsshouldhavethepotentialforhighgrowth(at
leastinrevenues)overlongperiods.Whenlookingatthesize
ofthefirm,youshouldlooknot onlyatitscurrentmarket
share,butalsoatthepotentialgrowthinthetotalmarketfor
itsproductsorservices.Afirmmayhavealargemarketshare