Growth Down Under

Like it or not, stock markets value the growth potential of all public companies every trading day. These days in particular, the share prices of many companies have a giant built-in growth premium, and should they fail to make good on the market's expectations, their shares are set for a tumble. If companies with small or negative growth expectations are to raise their share prices, they must prove that they are developing new revenue and profit streams. Consultants in McKinsey's Australian office have documented the growth expectations built into the share prices of Australia's leading companies (exhibit). The value of current earnings, shown in the purple bar on the left, represents the net present value of earnings expected by analysts for the year 2000, in perpetuity, discounted at the relevant risk-adjusted cost of capital. The growth expectations depicted in the green bar on the right measure the difference between the market capitalization of a company on July 23, 1999, and the value of its current earnings stream, This reflects the market's view of the company's ability to create long-term value; the higher the premium, the greater the market's expectations for post-2000 earnings growth. As the left side of the exhibit shows, growth expectations account for 50 percent or more of the current stock prices of 24 of Australia's largest companies. In other words, the market believes that the value of the business they have yet to create equals the total value of the business they have created throughout their entire histories. The right side of the exhibit lists large companies whose growth possibilities, as seen by the market, range from less than 10 percent at best to negative at worst. The market believes that these companies will have difficulty adding value to the assets they control and that the inevitable attrition of old business will proceed faster than the creation of new replacements for it. Certain companies in this class have developed initiatives to move ahead, and the market has misjudged some of them harshly. But few are as healthy as the companies in the top quartile. Why does the market expect some businesses to have rosy futures and other, seemingly similar ones to falter? McKinsey research on sustaining long-term profitable growth suggests that the market spots companies that keep their pipelines filled with winning businesses and rewards their share prices with high growth premiums. In other words, as a company's businesses and revenue streams mature, there must be others, representing new sources of profit, ready to take their places. Mehrdad Baghai is a principal, Belinda Everingham is a consultant, and David White is a director in the Sydney office; Share prices of large Australian companies,July 23, 1999 Value of current performance Company Share price, Contribution to by rank local currency share price, percent The top 25 (of 100) 1. Transurban 1815.00 2. ecorp 2.46 3. Powertel 1.81 3 4. Hills Motorway 4.24 8 5. Computershare 18.50 16 6. Lihir Gold 1.10 23 7. MIM Holdings 1.26 25 8. Pasminco 1.72 27 9. Cable & Wireless 3.71 29 Optus 10. Westfield Holdings 9.89 29 11. BHP 17.69 32 12. Coca-Cola 3.02 33 Beverages 13. Australian Stock 11.69 36 Exchange 14. CSL 12.72 36 15. …