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 attributable to takeovers, acquisitions or mergers. Because takeovers, acquisitions and mergers do not bring about profits generated within the company, they result in what is instead considered inorganic growth.
BREAKING DOWN Organic Growth
Organic growth strategy seeks to maximize growth from within. Often, companies will utilize revenue and earnings growth, on a quarterly or yearly basis, as the performance metrics by which to gauge organic growth. The pursuit of organic sales growth often includes promotions, new product lines or improved customer service. This type of growth is important because 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 — a feat that often reflects in a higher stock price or increased dividend payouts.
In some industries, particularly in retail, organic growth is measured as comparable growth or comps. Comparable-store sales, and sometimes same-store sales, figures give the revenue growth of existing stores over an elected period of time. In other words, comps do not factor in growth from new store openings or M&A activity, which instead reflect in a firm's top-line revenue figure.
Inorganic growth can also be desirable as long as it is being paid for with a 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.
An Example of Organic Growth
Firms such as Walmart, Costco and other big-box retailers report comps on a quarterly basis to give investors and analysts an idea of their organic growth. Walmart grew its comp sales by 2.6% in the fourth quarter of its fiscal year 2018 — a clear example of organic growth that Walmart's CEO attributed to accelerated sales (and increased demand) in the firm's fresh meat, bakery and produce departments. In addition, the retailer said its e-commerce sales jumped 23% year over year. However, with a slew of e-commerce-related acquisitions in the preceding years and quarters, this figure is not reflective of organic growth.
A Risk Analysis of Organic vs. Inorganic Growth
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, however, another scenario to consider. 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 its 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.
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 on its business model, which may not be favorable to investors.