A Note on Sustainable Growth

Does perpetual “sustainable” growth truly exist? 

The sceptic in us says no. This concept has also proliferated itself under the guise of investment styles, such as “buy shares of the best-in-class companies, they will continue to grow and dominate the future”.

Is it truly possible to pick the future winners based on market dominance and perceived innovation? Are the current conditions that make a particular company to be deemed “best in class” sustainable? Can a business sustain its growth in a finite world, where human creativity is infinite – where new and amazing innovations constantly redefine the market? Surely not.

Picking the winning stocks can be exceedingly rewarding, but one needs to monitor carefully when growth slows, as it inevitably will. We say this because history is littered with examples of this. A history where companies that seemed to have insurmountable “moats” have become subsequent laughing stocks and deemed obsolete. From Myspace, Kodak, Blackberry, Nokia, Motorola, Yahoo, Blockbuster…the list goes on and on – companies that failed due to their inability to grow and innovate. 

In the late 20th century, Kodak once cornered the photography market; this is a well-documented story. However, they failed to adapt to the rise of digital technology and photography, which ultimately led to its bankruptcy in 2012.This sequence of rise and fall is true in almost all industries. Within the automotive industry, we have recently seen the rise of battery electric vehicles (BEV) as the world grapples with climate change. Previously, internal combustible engines (ICE) were seen as the primary energy technology for cars. Now, it’s slowly becoming accepted consensus that ICE vehicles have reached peak demand, and that other technologies will have to be adopted. The emergence and momentum behind BEV’s have led many to question the growth trajectory of ICE vehicles. Even the sustainability of BEV’s growth projections must be questioned in the wake of the nascent hydrogen engine technology, deemed by many to being an even cleaner alternative.

If the case keeps changing, how can we believe that the current “best in class” shares will expose us to future growth? The truth is that despite large investments in research and development, innovation cannot be monopolised.

In the local market (South Africa), while there haven’t been new industries emerging for some time, dominant players are being challenged. In a country where economic growth is low, real wages diminishing, markets not growing, this forces companies to innovate and often take market share from one another. Examples of this can be found in the pharmaceutical industry. It was not farfetched at one stage to believe that Clicks would continue to grow at high rates given our healthcare dynamics (ageing population, prevalence of communicable and non-communicable diseases etc.). While the company is still growing, the growth rate is slowing, owing to Dis-chem which is causing some disruption. Dis-chem is endowed with a management team hell-bent on competing hard (the type of management team we like). It’s not that the products they sell are superior, they are just highly competitive. Wherever there’s Clicks store, nearby is a Dis-chem. Therefore, can Clicks maintain the same historical growth rate given the formidable challenger that is Dis-chem? The future growth rates of the company will surely have to be tempered as relative market shares will shift through the years. Another tale is that of Pick ‘n Pay, a local food retailer which at some stage could do no wrong. However, more recently, Checkers adapted, innovated, competed hard and is winning (for now). 

It is important to note, that there is an unintended consequence of backing today’s winners and extrapolating the same growth into the future (as it is a complex task to model for disruption, which is by its nature sudden). A small disappointment in the company’s efforts to meet these lofty expectations can result in negative share price revisions. More recently, Tesla, which in our opinion released commendable results, missed analyst earnings expectations by a mere 2 cents!  The company’s share price fell as much as 5% before finally closing down 3% following these 4^th quarter results release. Can you imagine how much the share price would have fallen had the company missed expectations by 20 cents? Mind you, its sales were up 38% for 2023. Alphabet, another company that recently released its quarterly results, reported $48 billion for the revenue of its core search business. Narrowly missing analyst projections of $48.15 billion. The shares fell 6.5% in extended trading.

Again, as another example, at some point, it was inconceivable that Google would be challenged as the number one company in the world given its dominance.The broader concern is that growth expectations should soften on the back of emerging competition from generative AI enabled companies. This is obviously a simplistic approach in analysis, but the point remains, you cannot maintain high growth rates perpetually in a forever changing world. 

We are not advocating that one never invests in the winning stocks, getting it right can be a rewarding experience. Rather, the point we seek to drive home is that it is important to have some scepticism in how you ascribe future growth. We also understand that it’s hard to price an unknown future. What is the right multiple for an emerging industry like artificial intelligence or electric vehicles? It’s difficult to figure out, but, as analysts, we must strive to get to a logical and rational answer that takes all things into consideration – follow the numbers and not the narrative!  Our proposition is that we do our utmost best to figure out how much a high-flying growth company is likely worth and then seek to pay a lot less than that value for it, giving us as investors a fair margin of safety.