What It Is, and Why It Matters to Investors

What Is Organic Growth?

Organic growth is the growth a company achieves by increasing output and enhancing sales internally. This does not include profits or growth attributable to mergers and acquisitions but rather an increase in sales and expansion through the company’s own resources. Organic growth stands in contrast to inorganic growthwhich is growth related to activities outside a business’s own operations.

Key Takeaways

  • Organic growth refers to the growth of a business through internal processes, relying on its own resources.
  • Strategies for organic growth include optimization of processes, reallocation of resources, and new product offerings.
  • Measuring organic growth is done by comparing revenues year over year and comparable store sales.
  • Organic growth stands in contrast to inorganic growth, which is external growth, such as through mergers and acquisitions.

Understanding Organic Growth

An organic growth strategy seeks to maximize growth from within. There are many ways in which a company can increase sales internally in an organization. These strategies typically take the form of optimization, reallocation of resources, and new product offerings.

Optimization of a business focuses on continuing to improve a business’s processes to reduce costs and set appropriate pricing strategies for products or services. Reallocation of resources involves allocating funds and other materials to the production of best-performing products, while new product offerings seek to grow a business by introducing new goods and services that will add to profits and overall growth.

Organic growth allows for business owners to maintain control of their company whereas a merger or acquisition would dilute or strip away their control. On the other hand, organic growth takes longer, as it is a slower process to acquire new customers and expand business with existing customers. A combination of both organic and inorganic growth is ideal for a company, as it diversifies the revenue base without relying solely on current operations to grow market share.

Measuring Organic Growth

Companies will utilize revenue and earnings growth, on a quarterly or yearly basis, as the performance metrics by which to gauge organic growth. The pursuit of organic sales growth often includes promotions, new product lines, or improved customer service. This type of growth is important because investors want to see that a company in which they are invested in, or plan to invest in, is capable of earning more than it did the prior year—a feat that often reflects in a higher stock price or increased dividend payouts.

In some industries, particularly in retail, organic growth is measured as comparable growth or comps in a 13-week period. Comparable-store sales, and sometimes same-store sales, give the revenue growth of existing stores over a selected period of time. In other words, comps do not factor in growth from new store openings or mergers and acquisitions (M&A).

Real World Example

Firms such as Walmart, Costco, and other big-box retailers report comps on a quarterly basis to give investors and analysts an idea of their organic growth. Walmart grew its comp sales by 2.5% in the 53 weeks ending Jan. 31, 2020, excluding fuel—a clear example of organic growth that Walmart’s CEO attributed to a strategic focus on comp sales over new store openings by improving the in-store experience for customers.

Investment Analysis of Organic Growth vs. Inorganic Growth

If company A is growing at a rate of 5% and company B is growing at a rate of 25%, most investors would opt to invest in company B. The assumption is that company A is growing at a slower rate than company B, and therefore has a lower rate of return.

There is, however, another scenario to consider. What if company B grew revenues by 25% because it bought out its competitor for $12 billion? In fact, the reason company B purchased its competitor is because company B’s sales were declining by 5%.

Company B might be growing, but there appears to be a lot of risk connected to its growth, while company A is growing by 5% without an acquisition or the need to take on more debt. Perhaps company A is the better investment even though it grew at a much slower rate than company B. Some investors may be willing to take on the additional risk, but others opt for the safer investment.

In this example, company A, the safer investment, grew revenue by 5% through organic growth. The growth required no merger or acquisition and occurred due to an increase in demand for the company’s current products. Company B saw a decrease in revenue by 5%, which is a decline in organic growth. Overall growth increased due to acquisitions by borrowing money. Company B’s growth is completely reliant on acquisitions rather than on its business modelwhich may not be favorable to investors.

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