This market misunderstanding can be profitable
Growth is not sustainable.
During the ten years preceding COVID-19, the average company expanded at a low 2.8 percent per year, with only one in every eight recording growth rates of more than 10 percent per year.
The timeframes can be different based on industry and specific companies; however, at some point, the business will not be able to grow as it previously did.
Once declaration reaches a certain point, a business will plateau, and enter its mature stage.
Profitability will reach peak levels, and asset growth will begin to shrink.
Business is stable and the firm has successfully established itself in the market.
The market can detect this transition, but determining the fade is a difficult task. In this disconnect comes an opportunity for investors.
Research has shown the mature stage is the hardest to understand and predict.
After discussing the rise of Uber from a startup to a growth company, it’s now time to look at a company that has finished the cycle.
Today, we will look at a retailer that has made it past the growth stage and has seen the effects of the mature stage.
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Growth companies will peak at some stage, and that is when they become mature.
There aren’t as many customers to reel in. Gaining market share becomes increasingly difficult. The business continues to scale, however, the benefits of size are now marginal.
Despite these “negative” characteristics, there is one thing that stays stagnant, profitability.
Although the company is no longer growing at the same pace, a business in its mature stage will yield peak profitability for an unknown period.
Similarly, they will also often exhibit less volatility in their returns than other stages.
It is hard to capture the exact period of maturity, but an example is warranted to get a real-life image of what a mature company may look like.
Based on the criteria mentioned above, Macy’s (M) in the early 2000s showed signs of a firm that was at a mature level.
Dating back to the 1990s, Macy’s wasn’t the retailer we know today. It would take two large mergers and continuous store investment for the firm to reach peak square footage in 2006 of 158 million.
In the years to follow, asset growth would remain at negative levels, but profitability reigned high. Macy’s had reached an optimal point of store locations and size and would scale back on increasing its asset base.
Even in the face of the financial crisis, Macy’s posted ROA levels between 10% and 13% from 2008 to 2015.
Simultaneously, asset growth turned negative in each of those years.
Take a look.
Macy’s profitability and growth detail a rough outline of what a mature company looks like, but it is time to look at this stage from the market perspective.
First, it’s necessary to establish that companies may see their “mature” stage last for years, others may see this stage last for decades, and some still may see a reacceleration of growth.
That being said, our research indicates that the market heavily discounts businesses that are in the mature stage.
The market appears to overestimate the timeframe in which a mature will begin to fade out.
Out of the entire business life cycle, the mature stage yields the biggest deviation from market implied and actual results at 2.8%, on average.
As a result, if investors can find companies with a lower probability of fading than what is now priced in, they should be rewarded with a revaluation.
Now, there isn’t a definitive principle stating that mature companies outperform market expectations, but it infers a much larger percentage of mature companies overperform the broader market.
The largest takeaway should be that it may be worthwhile to screen and focus on companies that appear to be in their mature stages. On average, these companies have shown a greater chance of outperforming the market.
Joel Litman & Rob Spivey
Chief Investment Strategist &
Director of Research
at Valens Research