In a recent conversation on the Excess Returns podcast, NYU Professor Aswath Damodaran talked about his latest book, “The Corporate Life Cycle“, which argues that businesses, like people, age.
They start young, grow with vigor, reach middle age, and then — no matter how hard they fight it — begin to slow down. This natural cycle, he argues, should guide how we think about investing in companies.
Indeed, it should influence how management thinks about capital allocation and generating returns for shareholders. The trouble is, like a lot of us, companies usually refuse to act their age.
Gracefully accepting that a business is past its prime doesn’t necessarily mean giving up on growth, but shareholders are generally better served when management tilt towards a return of capital focus over the reinvestment of cash flows.
Sadly, there’s usually a lot of pressure from bankers, consultants, and investors to do the opposite. “Grow or die” is the clarion call, but more often than not it tends to destroy shareholder capital.
Damodaran highlighted some U.S. examples, but we’ve seen a lot of the same on the ASX.
Consider Telstra (ASX:TLS), which invested approximately $500 million into U.S.-based video streaming and analytics company Ooyala about a decade ago. Long story short, they wrote the whole thing down to zero in 2018. Oh, and then there was Telstra TV and an ill-fated expansion into Asia, neither of which did any favours for investors.
Sure, the telco business wasn’t really growing, but a bigger dividend would’ve helped ensure shareholders still got a decent return. Instead, Telstra was left with write-offs and underperforming assets, showcasing the dangers of chasing growth outside your core competency.
Then there’s National Australia Bank (ASX:NAB), whose ill-fated expansion into the UK with the acquisition of Clydesdale and Yorkshire Banks ended in a similar debacle. Despite grand ambitions, NAB ended up writing off over $4 billion and incurring significant wasted costs. The bank eventually exited the UK market, and its shareholders paid the price for management’s determination to expand internationally, rather than focusing on improving core operations.
In fact, once you start doing a bit of Googling, you’ll find plenty of high-profile examples of large companies chasing growth outside their core operations, only to destroy shareholder value in the process.
Woolworths (ASX: WOW) ventured into hardware with its Masters Home Improvement chain, costing shareholders billions. The same can be said of Foster’s push into wine with its acquisition of Southcorp, and Coca-Cola Amatil’s attempt to enter the premium beer market through its stake in Pacific Beverages.
To be fair, there are examples of large, well-established companies pursuing and achieving outstanding growth.
CSL (ASX:CSL) embarked on a global growth strategy not long after it was privatized in the ‘90s, and since then, it has delivered exceptional returns for shareholders. The key to CSL’s success? Sticking to what it knows best — biotechnology and blood plasma therapies — and expanding methodically into international markets that fit its strengths.
While there’s always an element of luck involved, understanding a company’s core competencies and competitive strengths (and sticking to them) appears to be key. CSL didn’t rush into new markets or launch businesses in unfamiliar industries. Instead, it gradually expanded its expertise in blood plasma products and biotech, building a strong, defensible position in a growing market.
Still, this is the exception to the rule.
Just as an individual who is approaching retirement starts thinking more conservatively, a mature company should focus on preserving value rather than chasing ambitious but risky growth opportunities.
This means focusing on operational efficiencies, maximising free cash flows and dividends or (if the share price is low enough) buy-backs. By all means seek growth, but do so cautiously and only when you can leverage your competitive strengths.
Sometimes, knowing when not to grow is the most prudent decision a company can make.
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