DEFINITION of Growth Firm
A growth firm is a company growing faster than its peers or the broader economy. Although there are no hard-and-fast rules of defining growth, these firms generally have increased annual revenues by more than the industry average over a sustained period. A firm is not classified as a growth firm if revenues or other financial metrics surge for one quarter and relax in subsequent periods. This progress must be demonstrated over several years to legitimize the quality of growth.
BREAKING DOWN Growth Firm
A growth firm has the ability to scale up their business rapidly. One consequence of this rapid growth is the firm's balance sheet may come under significant pressure as capital expenditures (CAPEX) escalate in line with business growth. While growth firms in the early stages may not be profitable, investors are generally willing to take a longer-term view in hopes of rapid revenue growth eventually translating to profits and cash flow.
This was the case for Amazon (AMZN) over the past 20 years. The retail giant worked tirelessly to undercut competitors and reinvest earnings into the business as a means of carving out an extensive moat. For years, this came at the expense of the bottom line. But the retail space increased in dominance and web services found its footing, leading to Amazon's first profitable quarter in 2015. Some companies aren't as fortunate and prolonged revenue growth doesn't result in profitability.
Growth firms can be found in any sector, but they tend to be clustered in areas such as technology and life sciences. As some of the biggest and most successful companies have demonstrated, size is also not a necessary condition of the growth label. Look at Amazon. Its one of the five largest companies in terms of market capitalization and continues to post over 20% top line growth each quarter.
Common Misconceptions of a Growth Firm
Many investors equate growth almost exclusively with the tech sector but many other industries like real estate and manufacturing maintain their fair share of growth firms. Some of these include online furniture retailer Wayfair (W), home improvement retailer Home Depot (HD), and fast food giant McDonald's (MCD), among many more.
Other fallacies associated with growth firms include the size of the company, the source of financing, years of existence, and location of the firm. In other words, most growth firms are not VC backed technology companies borne out of Silicon Valley in the past 5 years. Some of them have existed for decades and only recently received an opportunity to succeed.