Investing in companies is a great way to build wealth and create financial stability. In this blog, A company lifecycle I’m going to take you through a company’s lifecycle from initial idea to ultimate demise and discuss the key moments when you should buy shares and when you should sell shares.
A Company lifecycle – The 5 stages
There are 5 principle stages to a company’s lifecycle. Launch, Growth, Shake-out, Maturity and Decline. Let’s go through each one and identify buy and sell signs for each stage
Stage 1 – Launch
Capitalism has its’ faults but if you live in a capitalist country you can wake up one morning and decide to start a business. Chances are you’re going to need some cash to get going. You may have some of your own, you may need to go to the bank or go and see some venture capitalists that specialise in startups. You’ve got the cash and you’ve launched your business. Let’s say it’s a restaurant idea in London and it’s going well. You have 10 restaurants and want to expand more and need investment. Investing at this early stage is called ‘SMART MONEY’ because you’re investing right at the start. It offers maximum returns but it’s also fraught with danger because you don’t know what’s going to happen. Let’s take a look at an example.
Jeff Bezos woke up one morning and decided to leave his well paid job and start an on-line book store. And the rest is history. We can all see what he did with amazon now but the share price chart shows a very different picture. It took 18 years for those initial investors to start to see a return on their cash . 18 years is a long time to be patient and my guess is that the SMART MONEY didn’t have the stomach to wait that long. I don’t invest in IPO’s for that very reason. I would rather wait and see tangible evidence of things happening.
Growth
Great. You’ve launched. You’ve ironed out the processes, employed the right people and now it’s time to grow. Exciting times. As an investor you’ve waited for this moment. The company is established, growing sales and profits, controlling its’ cashflow and is expanding. The share price will always rise with increasing net profits so now is a time to jump in and buy shares right? Well yes and no. Whilst investing at this stage reaps serious rewards the growth phase is fraught with banana skins. Grow too fast and cashflow becomes an issue, grow too slowly and competition can rip the table cloth from under your nose. Your idea is now exposed to the wide world and can be copied and done better by anyone else.
The growth phase is a BUY time for me but I pay close attention to the following.
- Competition- who is in the same industry and are they doing better
- Economic moat- How easy is it to copy the idea?
- Debt- Increasing debt is OK as long as they can repay the interest payments with cash generated from operations ( CURRENT/QUICK ratios and INTEREST COVER)
Stockopedia provides all the information needed to make informed decisions regarding the liquidity of the company. Any signs of degradation in this area of the company’s financials and it’s probably time to sell. It may be nothing and you sell to early but it’s always prudent to err on the side of caution.
Growth phases can take 20 years or more so there’s plenty of opportunity to jump on the band wagon and make decent profits.
Shake-out
This is a dangerous phase for companies and investors. The launch has been successful, growth has been fantastic but everything goes sluggish. Sales slow down, profits reduce, costs rise. The company has reached a saturation point; competition has entered the market and a big shake up is required. Large companies are beadily eyeing up whether they can do it cheaper and more efficiently. If the sales have slowed and profits reduced the share price will stagnate and the fund managers ( under pressure from their high net worth clients to maintain good returns ) will sell off and the share price will start to fall.
Without a crystal ball it is difficult to predict whether the company can revive its’ fortunes or will collapse under pressure. The only saving grace in this stage is company buy outs may occur. Large companies looking to get into the market may decide a better option than setting up in competition is to buy the expertise, infrastructure and technology from an existing firm. You wouldn’t sell your precious car worth £20,000 for £20,000 would you? You’d maybe sell it for £35,000 and it’s the same for companies. If the company is worth £300million a prospective purchaser would have to offer significantly more to acquire the company and that sum is usually a 30% markup on share price value.
Maturity – The boring steady eddies
When the business matures, it commands a huge chunk of the market and growth slows. The only way to increase revenue is by acquiring other businesses, Coca Cola, for instance doesn’t just sell Coke. It distributes hundreds of other brands including Schweppes, Fanta, Powerade and costa coffee. The cashflows are exceptional so this is where you’ll find the majority of dividend paying companies. Institutional investors such as large fund managers and pension funds buy large chunks of these companies for stability and dividends. If you’re a fund manager, IBM won’t make you a fortune but you won’t get the sack for having IBM shares in your portfolio.
The share price remains relatively stable in these types of companies except in certain circumstances. Who remembers the Pepsi challenge ad ( late 70’s). This prompted the Coca Cola management team to panic and they created a new recipe called NEW COKE. The share price tanked. An astute investor such as Warren Buffett realised this was a mistake and bought as much stock as he could (at the reduced price). Also, government legislation can influence the share price too. Restrictions on smoking, sugar tax on soft drinks, mad cows disease on beef supplies will all affect the share price but as long as its not terminal, there will be opportunities to either top up or start buying at a discount price.
Decline
Sometimes the unsinkable ship sinks as the story of the Titanic famously highlights. Kodak and Toysrus are prime examples of companies that have fallen off the tree. I’m still surprised to this day that the Kodak management team didn’t see the digital age coming. It was blatantly obviously to me. They didn’t react to it and the inevitable happened. ToysRus simply didn’t react to e-commerce, weren’t looking after their customers and not controlling their debt. Stockopedia provides all the necessary figures to inform us of declining sales, profits and increasing debt levels so there’s no excuse to keep shares if the evidence and emerging technologies points unfavourably towards the future. Time to sell ( even if you’re in a negative position) and go looking elsewhere. Sometimes it comes out of the blue and there’s nothing you can do about it. Take it on the chin and remember the rule of 6. If you’re right six times of of ten, you’ll be making money in the stock market.
A company Lifecycle – Conclusion
I generally stick to the middle part of a company’s lifecycle. There’s to much uncertainty surrounding companies that have just launched and just because you’ve missed the initial power surge in share price doesn’t mean that good profits can’t be made once the company is well established. I avoid companies that don’t seem to have any growth potential unless I’m buying them for the dividend. I look 20-30 years ahead ( even though I will be worm fodder by then) to make sure that they have the ability to grow into new markets and that their products will be needed by us as consumers. Shake outs happen all the time and this is a wonderful place for the Turnaround strategy. Humans become lax, lazy, sloppy and take their eye off the ball. Wait for a shake out ( it’ll be in the news ) and watch the share price drop. The mature phase is where you’ll find the dividend paying companies. Nothing wrong with re-investing the dividend in more shares. The more shares you have the bigger the dividend next time round and a good way to avoid the demise phase is to look at the products they sell. Is there anything coming up that can make their products redundant? Happy hunting.
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