What is 'Organic Growth'
Organic growth is the growth rate a company can achieve by increasing output and enhancing sales internally. This does not include profits or growth acquired from takeovers, acquisitions or mergers. Takeovers, acquisitions and mergers do not bring about profits generated within the company, and are therefore not considered organic growth.
BREAKING DOWN 'Organic Growth'
Every year, companies create a new growth objective. The goal is to grow revenues and earnings higher than they were the last quarter or last year. This is because investors love growth. Investors want to see that a company in which they are invested, or plan to invest in, is capable of earning more than it did the prior year.
Not All Growth Is Equal
The best way to explain the importance of differentiating between organic and inorganic growth for investors is with an example.
If company A is growing at a rate of 5% and company B is growing at a rate of 25%, most investors opt for company B. The assumption is company A is growing at a slower rate than company B, and therefore has a lower rate of return. There is another scenario to consider, however. What if company B grew revenues 25% because it bought out its competitor for $12 billion. In fact, the reason company B purchased its competitor is because company B’s sales were declining by 5%.
Company B might be growing, but there appears to be a lot of risk connected to this growth, while company A is growing by 5% without an acquisition or the need to take on more debt. Perhaps company A is the better investment even though it grew at a much slower pace than company B. Some investors may be willing to take on the additional risk, but others opt for the safer investment.
Organic vs. Inorganic Growth
In this example, company A, the safer investment, grew revenue by 5% through organic growth. The growth required no merger or acquisition, and occurred due to an increase in demand for the company’s current products. Company B grew revenue through acquisitions by borrowing money. In fact, organic growth declined by negative 5%. Company B's growth is completely reliant on acquisitions rather than its business model. This is not a good development.
In some industries, particularly in retail, organic growth is referred to as comparable growth or comps, referring to sales based on a comparable base of stores or retail outlets. Inorganic growth is not bad as long as it is being paid for with the company's cash rather than debt or equity financing. A combination of both organic and inorganic growth is ideal as it diversifies the revenue base without relying solely on current operations to grow market share.