Facebook today is very different today from the much smaller company that was born in Mark Zuckerberg’s dorm room. My, Mark Zuckerberg, how your child has grown. While Facebook’s growth has accelerated at an astonishing rate, the company faces entirely different issues than it did when the company was beginning to crawl.
The Facebook of 2010 was wildly popular but investing into its already hot stock required some significant leaps of faith. There was some doubt about being able to earn enough return on a service offered free to users, and whether Facebook would thrive in the face of competition. Now Facebook has become so dominant that it faces continuous government scrutiny, but it has developed into a far more stable and predictable business than it was when it first went public. The big question now is how it can continue to grow its gigantic business at an attractive rate. That has led it to buy out competitors and venture into virtual reality headsets.
Companies tend to follow a predictable business life cycle. Since stocks in these different life stages have different risk/return tradeoffs, you should always consider where one of your stocks is in its life cycle. Authors use different names for these stages, but, broadly speaking, they’re broken down into startup, growth, maturity and decline. Companies won’t always go neatly from one stage to another.
New companies are fighting first for buyers’ attention. Profitability takes a second seat to research and development. Funding the company’s initial growth is difficult and/or expensive. There’s doubt about whether a company can survive. Investors accept that risk in exchange for buying a company that might grow many times its current size. Unfortunately, most companies will not survive, but skillful investors are able to profit from their infrequent home runs.
Growth companies face different challenges than startups. They need to manage production to deliver as much product as their markets demand. The stock’s value reflects investors’ optimism and may even be overpriced. If the company continues to maintain or even increase its growth rate, all is well. But should the company disappoint, or investors become less enamored of the future, the stock can take quite a hit.
Managers pursue growth because of the effects on stock price. That can lead them to make unwise acquisitions or drift too far from their core businesses, reducing the profits available to buy back stock or pay dividends to shareholders.
Mature companies are often dominant in their niche but can have few profitable opportunities for growth. Their profits depend less on innovation and more on demand from their customers. Utilities are good examples of mature companies. Their roles are to be cash cows; profits should be paid out through dividends and buybacks instead of investing into new businesses with less visibility. As long as they can maintain their high profitability, they can be attractive investments, especially when bought at a low price.
The tricks to investing well include identifying successful startups, doing a better job than most about projecting growth, or how long a cash cow can be milked. And, especially, buying those opportunities at attractive prices.