Higher Growth Always Leads to Higher Value: Truth or Myth?

Growth is a magical word in the world of investing and business. The promise of growth can make stock prices soar, attract new customers, and give a company the kind of momentum that propels it into the stratosphere of success. But does higher growth always lead to higher value? Intuitively, the answer seems obvious. More growth means more revenue, higher profits, and, ultimately, a more valuable company. But the reality, as with most things in finance, is far more nuanced.

Having spent over 15 years as a valuation professor and hedge fund manager, I’ve seen the excitement and pitfalls of chasing growth play out across boardrooms, trading desks, and investor portfolios. Growth can be a tremendous driver of value, but it can also mislead if misunderstood. Let’s dive deep into this topic, exploring the principles, real-world examples, and lessons you can use to navigate the growth-value dynamic effectively.

The Building Blocks of Value: Why Growth Matters

Before we examine the complexities, let’s start with the basics. At its core, a company’s valuation reflects the present value of all the cash flows it is expected to generate in the future. In simpler terms, it’s the sum of all the money you expect the business to make, adjusted for the time value of money (a dollar today is worth more than a dollar tomorrow).

Growth enters the equation in two powerful ways:

1. Higher Cash Flows: When a company grows its revenues and profits, it directly increases the size of the cash flow pie.

2. Terminal Value: In most valuation models, a large portion of a company’s worth comes from its long-term or terminal value the expected cash flows beyond a forecasted period. The assumption here is that a higher growth rate leads to a bigger slice of this terminal value.

On paper, this sounds like a slam dunk. Higher growth = higher cash flows = higher value. But theory often clashes with the real world.

Real-World Examples: The Good, the Bad, and the Unexpected

The Good: Amazon’s Relentless Growth

Amazon is perhaps the ultimate growth story. In its early years, the company reinvested every dollar it earned into expanding its operations, from warehouses to cloud computing infrastructure. Investors were willing to accept razor-thin profit margins (or no profits at all) because they believed in the company’s long-term growth potential.

Fast forward to today, and Amazon is a trillion-dollar behemoth. Its high-growth strategy in the early 2000s laid the foundation for its dominance in e-commerce and cloud computing, both of which continue to generate massive cash flows. Amazon’s story highlights how sustainable, strategic growth can create enormous value.

The Bad: WeWork’s Growth Without a Plan

Contrast Amazon’s success with WeWork’s spectacular downfall. WeWork expanded aggressively, leasing office space worldwide in a bid to dominate the flexible workspace market. While its growth metrics (e.g., locations opened, members signed) looked impressive on paper, the underlying business model was deeply flawed. The company’s costs ballooned far faster than its revenues, leading to massive losses.

When WeWork attempted to go public in 2019, investors balked, and its valuation plummeted from $47 billion to near bankruptcy levels. This example underscores that not all growth is good growth. If it’s unsustainable or poorly executed, growth can destroy value rather than create it.

The Unexpected: Tesla’s Polarizing Growth Story

Tesla’s meteoric rise is a tale of growth defying traditional metrics. For years, skeptics criticized Tesla for its lack of consistent profitability, yet its stock price surged as investors bought into its growth story not just in electric vehicles but also in renewable energy and autonomous driving.

Tesla’s valuation has often seemed disconnected from its financials, leading some to label it a bubble. Yet its relentless focus on growth in high-potential markets has kept investors intrigued. Here, growth created value not through immediate financial returns but by fueling a compelling narrative about the future.

When Growth Doesn’t Equal Value

While growth is often a value driver, there are scenarios where it can fail or even backfire. Let’s explore some common pitfalls.

1. Growth Without Profitability

Growing revenue is easy; growing profitable revenue is hard. Take Uber, for example. The company’s rapid expansion into new markets and services like Uber Eats created an impressive growth story. Yet, years after its IPO, Uber has struggled to achieve consistent profitability. Investors have repeatedly questioned whether its growth is sustainable or whether it comes at too high a cost.

2. Growth That Overextends Resources

Aggressive growth often strains a company’s operational capacity. Peloton’s pandemic-fueled growth spurt is a cautionary tale. The fitness company couldn’t scale fast enough to meet demand, leading to production delays and customer dissatisfaction. When demand eventually cooled, Peloton was left with excess inventory and a plummeting stock price.

3. High Growth, High Risk

Growth often requires significant investments, which increase a company’s risk profile. This is reflected in valuation models as a higher discount rate. If the risks of achieving growth outweigh the rewards, the company’s value can decline. For example, biotech startups often face this dilemma: their groundbreaking research offers massive growth potential, but the high failure rates of clinical trials make them inherently risky.

Balancing Act: How to Assess Growth and Value

As an investor or business leader, it’s crucial to distinguish between good growth and bad growth. Here are some practical tips:

1. Look for Sustainable Growth

Not all growth is worth pursuing. Sustainable growth comes from expanding into markets where a company has a competitive advantage, strong customer demand, and operational capacity. For example, Apple’s growth in services (like iCloud and Apple Music) complements its hardware ecosystem, creating recurring revenue streams.

2. Understand the Growth-Cost Tradeoff

Growth often requires significant investments in marketing, R&D, or infrastructure. While these investments can pay off, they’re not guaranteed to do so. Companies that grow while maintaining healthy profit margins, like Alphabet (Google), tend to deliver more value than those that sacrifice profitability entirely.

3. Be Wary of Growth at Scale

As companies grow larger, maintaining high growth rates becomes more challenging. For instance, Microsoft’s early growth was exponential, but as it became a global tech giant, its growth naturally slowed. Yet, the company’s focus on high-margin businesses like cloud computing has ensured that even modest growth contributes significantly to its valuation.

Why Growth Still Matters (Most of the Time)

Despite its complexities, growth remains a critical driver of value for one simple reason: investors pay for future potential. Companies that can demonstrate a clear path to sustained, profitable growth often command premium valuations, even if their current financials don’t justify it.

However, the market is quick to punish companies that fail to deliver on growth expectations. This is why understanding how a company achieves growth is just as important as the growth itself.

Key Takeaways: Growth and Value in Perspective

1. Growth Alone Is Not Enough: Focus on the quality of growth, not just the quantity. Sustainable, profitable growth creates the most value.

2. Beware of Overhyped Narratives: Companies priced for perfection can disappoint if they fail to meet lofty expectations. Always assess the risks alongside the rewards.

3. Context Matters: The growth-value relationship depends on factors like industry dynamics, company size, and market conditions. Tailor your analysis accordingly.

4. Be Patient but Skeptical: Growth stories take time to unfold, but don’t hesitate to question unrealistic assumptions.

Growth may not always lead to higher value, but understanding its nuances can help you make smarter decisions as an investor or leader. Have you encountered companies where growth created or destroyed value? Let’s discuss in the comments below your insights could spark a valuable conversation!