The value of this score reflects the level of growth of the company during the last seven accounting periods, measured by the level of income and free cash flow.
How to use the score
A high value for this score will indicate that the company is in an expansion phase showing large growth levels in the last accounting periods. A low value will indicate little growth. A value of 0 in the score will indicate zero or negative growth.
The following table can serve as a reference for the use of this score:
|Score value range||Interpretation|
|0 - 5||Small growth|
|5 - 7||Fair growth|
|7 - 10||Great growth|
Growth can be measured in different ways according to the importance we assign to different accounting variables associated with it: revenues, profits, cash flows, assets, number of employees, among others.
It can be thought that the best way to measure the growth of a company is by using to the growth of its profits as a proxy. If a company earns more in each accounting year it is certainly growing. The problem of relying exclusively on profits as a proxy of growth is because of all the accounting variables that affect its calculation. There are certain accounting policy decisions that can cause an increase or decrease in profits without any true economic causes for its variation. For example:
- Changes in the amortization and provisioning policies
- Changes in fiscal rules
- Nonrecurring gains (for example, by the sale of a part of the business or of a certain asset)
A better way to measure growth, the one used by Gradement, is based on considering mainly the level of revenue in your calculation. Profits are always a direct consequence of this revenue. In the calculation of revenue, many fewer accounting variables has to be estimated, making its value more reliable and less subject to potential manipulation.
There are three main variables that may make any company increase its level of revenue. The increase in value of any of this variables, ceteris paribus, will result in an increase in the revenue and therefore in the value of the growth score calculated by Gradement:
- Increase in the level of sales of existing company's goods and/or services (because of an increase in the company's market share)
- Increase in the selling price of the goods and/or services sold by the company (provided that such increase does not imply a decrease in the quantity sold)
- Initiating the sale of new goods and/or services (through, for example, acquiring another business or opening new market lines)
Free cash flow
The other variable used by Gradement in the growth calculation, albeit with a lower weight than the level of revenue, is the change in free cash flows. This variable is a better indicator than net income of the free resources generated by the company during any accounting the period. The free cash flow will increase whenever:
- Revenue increases
- A decrease in certain spending accounts (operation cash flow, current assets and/or capital expenditures)
- A reduction in the company taxation level
In accordance with the principle of prudence that must govern all investment decisions, the company Grade does not include in its calculation this measure of growth. Past growth is no guarantee that growth will continue over time. Growth is almost never be sustained forever. The extraordinary profits of any business that grows will always attract competition. That competition, if there are insufficient barriers to entry into the growing enterprise sector (measured with the Industry barriers score), will cause a reduction in the company's market share and thus a reduce both revenue and free cash flow growth.
Although the Grade does not incorporate this measure of growth, under equal conditions (if the other scores have similar values), it will always be more attractive to invest in one company that shows greater growth than another. Since the Grade does not include any growth forecast, the investment in the company will be attractive even if there is no future growth. Any future growth will therefore result in greater return on investment than originally planned.