Analyzing and communicating revenue growth

By Werner Rehm , Vartika Gupta, CFA and Sanchit Jain, FRM

Revenue growth is considered a key element in benchmarking a company's performance. Rightly so, as it is one of the key levers for value creation.? However, revenue growth simply calculated from reported revenues can generate misleading results since it can be distorted by currency fluctuations, mergers and acquisitions, or, in rare situations, by changes in accounting standards. What really matters is the sustainable, organic growth a company can generate.

Therefore, it is crucial to eliminate distortions caused by external factors to obtain a more accurate estimate of organic growth for meaningful peer comparisons. For example, in the exhibit below, evaluating company performance based on total growth might suggest that Company A is superior. However, when we exclude inorganic growth and currency effects, Company B emerges as the stronger fundamental performer.

In particular, currency effects are increasingly becoming relevant with more and more companies expanding geographically. A rise in revenues may not necessarily reflect increased prices or greater quantities sold but simply depreciation of a company’s home currency. Though not frequent, accounting changes also can cause revenues to meaningfully increase or drop from one year to another.

Investors: Estimating revenue growth

In some industries, fortunately, organic growth metrics are being reported on a consistent basis. In retail, same-store sales growth and the number of stores are as fundamental as they get, especially when they are also reported in price vs. volume metrics. Some companies systematically provide revenue and earnings "bridges" with components of growth. In consumer packaged goods, for example, our colleague Susan Nolen Foushee tracks 30+ companies and disaggregates their reported growth into M&A, currency, price, volume, and mix effects purely on their published data. [1]

Unfortunately, not all companies provide enough data to get to the underlying organic growth rates. In these cases, some tricks can help to estimate the effect. For example:

• For M&A, you can get a list of acquired companies from S&P or similar data sources and estimate top-line in-year M&A impact from the reported revenue of the targets and the closing dates. Unfortunately, for small deals with private companies, companies tend not to report these numbers, which could have a meaningful effect if there are many deals in a year. Peer revenue multiples can be used as an estimate for revenue if deal value is available (e.g., from the cash flow statement). Obviously, these tend to be very rough estimates.
• If currency effects are meaningful, disclosures of regional sales can be used as a proxy in combination with effects reported in the statement of comprehensive income or balance sheet positions. Again, this is, at best, a rough estimate - but there is little other data available.
• In some industries, you can estimate volume data from other sources. This is easier in commodity industries like oil and gas, mining, and so on, industries that straightforwardly report unit sales like automotive and airlines, and impossible in others.

None of this is perfect, and some is, at best, rough guesswork. If you have access to management, it is always interesting to get feedback on your numbers. And if enough investors have the discussion, you might convince the company to disclose their own estimates.

Companies: Disclosing revenue growth

Instead of making it a guessing game for investors and analysts, it would be a win-win if companies could be more transparent in their filings. A split between organic and inorganic growth at both the company level and individual business unit would be a good start. Adding proforma numbers to currency and other effects adds transparency and granularity. And it will help with guidance.

For past performance, we suggest revenue and, ideally, EBITDA or operating profit bridges (excl., one-time cost). A suggestion for the order of analysis would be:

1. First, the growth from M&A. We feel that this is a must in all situations. Given that you know the revenue you acquired, disclosing this should be easy, either as a dollar amount or as a percent growth impact, including a breakout by segments if you disclose segment revenue.
2. The second should probably be currency effects. This is by its nature a bit more of an estimate, but most importantly, it's a number you couldn't really manage going forward, so showing the impact on performance helps to make the link between guidance and results
3. At this point, investors will have a good feeling for underlying growth. Bridging price vs. volume vs. mix is incredibly helpful, especially during times of higher-than-average inflation. It is not always possible to do this consistently with the data above, or for that matter in complex businesses, but whenever possible, breaking the data down further is helpful.

This would allow for apples-to-apples comparison vs peers (assuming they also disclose). For example, Alcoa disaggregates EBITDA changes into nine drivers, including energy and raw material costs. It's even better if you can sort out other effects. For example, Thermo Fisher Scientific in 2023 showed organic growth vs. total growth for FQ4 2023 and then also disclosed the effect of COVID-19 testing revenue. These are just some examples - many companies have similarly great disclosures. Others don't.

This kind of disclosure has an additional benefit for guidance. Since you can't influence currency and inflation, you can now also be explicit about what you use for your guidance and provide sensitivities to investors. For example, Merck provides guidance for revenue growth, including and excluding about a 2% currency headwind and Alcoa provides the sensitivities of its EBITA guidance on commodity cost and six exchange rates.

Overall, everybody benefits from more granularity and transparency. The better investors can estimate the value impact from performance, the better for management incentives as well. And if management doesn't disclose, investors will use rough estimates anyway.

[1] These bridges are notoriously tricky as the path matters. You will get different numbers depending on whether you start with the price, currency, or M&A effect. This can't be helped. It's best to be consistent over time.