What are Growth Rates
Growth rates refer to the percentage change of a specific variable within a specific time period and given a certain context. For investors, growth rates typically represent the compounded annualized rate of growth of a company's revenues, earnings, dividends or even macro concepts such as gross domestic product (GDP) and retail sales. Expected forward-looking or trailing growth rates are two common kinds of growth rates used for analysis.
BREAKING DOWN Growth Rates
At their most basic level, growth rates are used to express the annual change in a variable as a percentage.
An economy's growth rate, for example, is derived as the annual rate of change at which a country's GDP increases or decreases. This rate of growth is used to measure an economy's recession or expansion. If the income within a country declines for two consecutive quarters, it is considered to be in a recession. Conversely, if the country has a growth in income for two consecutive quarters, it is considered to be expanding.
Growth Rates Used to Assess Companies and Investments
Growth rates are utilized by analysts, investors and a company's management to assess a firm's growth periodically and make predictions about future performance. Most often, growth rates are calculated for a firm's earnings, sales or cash flow, but investors also look at growth rates for other metrics, such as price-to-earnings ratios or book value, among others. When public companies report quarterly earnings, the headline figures are typically earnings and revenue, along with the growth rates (quarter over quarter or year over year) for each.
Amazon, for example, reported full-year revenue of $177.9 billion for 2017; this represented growth of 30.8% from 2016 revenue of $136 billion. Amazon also reported that its earnings totaled $3 billion in 2017, compared to $2.4 billion the prior year, so the firm's growth rate for earnings on a year-over-year basis was 28%.
A compound annual growth rate (CAGR) is a specific type of growth rate used to measure an investment's return or a company's performance. Its calculation assumes that growth is steady over a specified period of time. CAGR is a widely used metric due to its simplicity and flexibility, and many firms will use it to report and forecast earnings growth.
Industry Growth Rates
Specific industries also have growth rates. Each industry has a unique benchmark number for rates of growth that its performance is measured against. For instance, companies on the cutting edge of technology are more likely to have higher annual rates of growth compared to a mature industry such as retail. Industry growth rates can be used as a point of comparison for firms seeking to gauge their performance relative to their peers.
The use of historical growth rates is one of the simplest methods of estimating future growth of an industry. However, historically high growth rates do not always indicate a high rate of growth looking into the future as industrial and economic conditions change constantly and are often cyclical. For example, the auto industry has higher rates of revenue growth during periods of economic expansion, but in times of recession, consumers are more inclined to be frugal and not spend disposable income on a new car.
Example of Macroeconomic Growth Rates
In addition to GDP growth, retail sales growth is another important growth rate for an economy because it can be representative of consumer confidence and customer spending habits. When the economy is doing well and people are confident, they increase spending, which is reflected in retail sales. When the economy is in a recession, people reduce spending, and retail sales decline.
For example, second-quarter 2016 retail sales growth for Ireland was reported in July 2016, revealing that domestic retail sales flatlined through the second quarter of the year. It is believed that political instability within the country, combined with the results of the Brexit vote in June 2016, caused Ireland's sales to stall. While some industries, such as agriculture and garden, showed positive growth, other industries within the retail sector counteracted that growth. Fashion and footwear had negative growth for the quarter.