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What Is The Difference Between A Growth Company And A Growth Share?

growth

In investing, terms like “growth”, “value”, and “speculation” are often used. For instance, there are “growth companies”, “growth shares”, “speculative shares”, “value shares” etc.

There’re yet more examples, but what is interesting here is that a growth share may not necessarily equate to a growth company. In fact, a growth company can even be a speculative share.

Before you get any more confused, let’s look behind the drapes to see what they really mean.

So near yet so far

The term “growth company” was actually defined way back in the 1960’s by financial theorists, Merton Miller and Franco Modigliani (the pair is most famous for their M&M theorem regarding a company’s capital structure). The two defined a growth company as a company that has the ability to continuously earn a rate of return on its investments that are higher than its cost of funding.

For example, let’s imagine a firm investing in a new project by funding it completely with a bank loan. If the loan costs the company 5% in annual interest payments but the company’s project can deliver a 10% return, the company has successfully earned a rate of return that’s higher than its cost of funding. With Miller and Modigliani’s definition, such a company would thus be a growth company.

Locally, companies such as Super Group (SGX: S10), Dairy Farm International (SGX: D01), and Jardine Cycle & Carriage (SGX: C07) can be considered as growth companies given their high growth rates over the past 10 years; between 2003 and 2013, earnings at the trio have grown at a compounded annualised rate of 21.1%, 14.8%, and 14.9% respectively.

So what is a growth share?

A growth share on the other hand, is simply a share that is expected to outperform the broader market’s return in the future. In that sense, a growth share does not necessarily need to be a growth company; shares of a company that have a price severely below their true economic worth can be a growth share as well even if the company’s businesses can’t grow.

Now, a growth company may or may not be a growth share. That’s because growth companies tend to be awarded a higher valuation by the market; with high expectations of future growth being priced into the shares of a growth company, the company’s eventual share price performance might be lacklustre even if its business does grow.

For a growth company to become a speculative share, it would simply take excessively high valuations to be awarded to its shares by the market. When expectations are too high, even the shares of a fast-growing company might actually fall in the future when the market gets a reality check on the company’s ability to grow.

Foolish Summary

In investing, the market’s current expectations plays a large part in the future performance of a share’s returns. As such, it is important for investors to understand the difference between a growth company and a growth share. 

 

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Stanley Lim doesn’t own shares in any companies mentioned.