The Importance of Revenue Growth in Stock Investing

By Stock Research Pro • January 29th, 2009

A company’s expected revenue growth is one of the most important factors investors use in determining the potential future stock price of that company. The value of common stocks is, of course, closely tied to the earnings power of the company, so an understanding of the company’s growth potential for both the near and long-term timeframes is required in making a sound investment decision. Growth rate calculations are especially important for start-up companies which may currently have very little net income but an expectation of high future growth rates.

The Importance of Revenue

Revenue is simply the amount of money that the company receives during a specified period of time. The revenue calculation is the number of goods or services sold during that time period multiplied by the price. The result is referred to as the “top line” or “gross income” figure. It is from that figure that costs are then subtracted to arrive at net income. Revenue growth is often seen as more valuable than the growth in net income because net income can increase with cost-cutting measures. While there are limitations on the extent to which costs can be cut there is – theoretically- no limit to the amount by which revenues can increase.

Looking at Historical Revenues

The trick for investors is in predicting future revenues. The use of the company’s historical growth rates is a simple method for estimating future growth. Looking at these numbers can help investors to become familiar with this baseline of the company’s historical performance.

Many investors start by looking that the 5 year revenue growth. The formula for this can be written as:

5 Year Revenue Growth = (Year 5 Revenue – Year 1 Revenue)
Year 1 Revenue

Using this formula, the investor can then build a table of to analyze revenues over recent years, often breaking these revenues out by company business segment. A CAGR calculation can then be used to annualize these growth rates.

Analyzing Other Factors

Of course the historical rates don’t always apply to future performance as both competitive and economic conditions tend to change over time. Savvy investors will also look at the company’s profit margins and other elements of the balance sheet to find problems that might be covered up by growing revenues.


The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax advisor.

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