Mastering the Corporate Life Cycle and Its Impact on Your Investments

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The corporate life cycle is an important yet often overlooked factor in investing. Like all things, companies age over time, with each phase having its own pros and cons. 

In this episode, Greg explores the corporate life cycle's impact on dividend growth investing. Using research from Morgan Stanley and Aswath Damodaran, he covers various stages of a company's life, including startup, young growth, high growth, mature growth, mature stable, and decline— with examples from companies like Rivian, Nvidia, Microsoft, PepsiCo, GE, IBM, Intel, AT&T, and Tesla. Highlights include the prolonged profitability in maturity phases, industry-specific aging rates, and risks associated with corporate debt and large acquisitions. Greg emphasizes understanding a company's phase for strategic investment decisions and the critical role of suitable CEOs.

00:00 Introduction
01:12 The Importance of Understanding the Corporate Life Cycle
02:10 Morgan Stanley's Five Stages of the Corporate Life Cycle
02:58 Key Metrics in the Corporate Life Cycle
05:39 Profitability and Debt in Different Stages
08:37 Cost of Equity and Capital in Mature Companies
11:10 Aswath Damodaran's Six Stages of the Corporate Life Cycle
14:08 Examples of Companies in Different Life Cycle Stages
20:15 Dividend Investing: High Growth to Mature Growth
21:48 Mature Stable Phase: Dividend Income and Growth
22:56 Challenges in Mature Stable Phase
24:24 Decline Phase: Managing Declining Cashflow
25:44 Narrative vs. Numbers in Company Growth
29:08 Pricing and Valuation Across Growth Phases
31:59 CEO Roles in Different Growth Phases
35:59 Conclusion: Investing Across Lifecycle Stages

Notes & Resources:

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Transcript

Greg Denewiler 00:11
This is Greg Denewiler, and you are listening to another episode of The Dividend Mailbox, a monthly podcast about dividend growth. Our goal is to stuff your mailbox full of dividend checks. When they grow over time, a funny thing happens, you create wealth. 

Welcome to episode 40 of The Dividend Mailbox. And today I'm going to just tell you right up front, I think this episode is going to be one of the more important ones we've done. It is not going to mention a specific investment idea, but if you really grasp the concept of this episode, it can really move the needle on your long term investment returns. We're going to talk about the corporate life cycle, and we're going to get into a few articles that have been written about it. I really would be surprised if you don't get something out of this, because if you're investing, this is just extremely important. We're going to talk about the corporate life cycle. You may wonder, as we start into it: Why is this really that important? You're going to find out that this concept is going to potentially be one of the biggest contributors or predictors to your long term success. This is especially true in the world where we live, which is dividend growth investing.

To get started, we're going to talk about a couple of articles that have come out. One of them was published by Morgan Stanley last fall, and it was titled Trading Stages in the Company's Lifecycle. And it was written by Mauboussin and Callahan. They give you an idea of how to define each phase. And then the second article we're going to get into a little later, it's by one of my favorites. I've mentioned him multiple times, Aswath Damodaran. He wrote a blog on the corporate life cycle, and then he also released a book about a month ago on the whole topic. But we're going to stick to the blog right now, just because this can get really deep fast. 

So let's look at the Morgan Stanley piece that came out. They basically divide the corporate life cycle into five stages: introduction, growth, maturity, shakeout, and decline. As you look at the different way they measured these stages, the first category they looked at was the simple average existence in each one of these stages. Then they gave you some rough parameters to kind of give you an idea of how to define each of these groups; sales growth, return on invested capital, debt to equity, and then cost of capital. 

One of your thoughts is going to be, well, the last place I want to be is in the decline phase. For the most part, that's true, but not always, but we'll get to that later. According to their research, the average company spent about nine years in the introduction phase, a little over 10 years in the growth phase, 15 years in maturity, 15 years in shakeout, and then 12 years in decline. The first observation you can make is every company performs differently, but maturity has the longest runway. This is where we live as a dividend growth investor. Companies ramp up relatively fast, but this maturity to shakeout stage can last for a long time. That really is important for us. 

When you look at sales growth, here, they use a three year average. For the introductory phase, companies experienced almost 11% sales growth per year. In the growth phase, it declined to 9.9%, but not by a lot. In the maturity phase, it was 5.4%. Shakeout was phase 3.6% and decline 4.1%. One would say, “Okay, in the growth phase, that's pretty obvious. Let's camp out there. 9. 9% growth is not that much lower than introduction, but the company has made it into a true survivor and they're still getting a lot of growth. Why not just live there and why in the world would I want to wait until a company matures? The growth rates potentially drop almost in half.” Well, the next category is going to start to give you a little bit more light into this window because it's kind of common sense that when a business is starting out, they're not profitable. And what they looked at is return on invested capital, how much a company earns on either equity or debt that they've actually invested into the company. In the introduction phase, they actually have a negative 3%, which makes sense because companies are struggling to get the product out or they're spending all their money on marketing and trying to introduce a product. Then the growth phase, profitability has definitely kicked in and now they're up to 9. 4%. In the Maturity phase, 11.5%. Here, they're starting to capitalize on creating brands and moats. So even though sales growth is slower, the business is more profitable. One of the things we're going to get into in a little bit is how that's priced, that really drives the bus. You can have higher growth, but if you have to pay a lot more for it and then it's not as profitable, many times is often better to get slower growth, but more profitability. If you get to the shakeout phase, it now drops down to 4.7%. Here you're running into problems where they're trying to protect margins, they're starting to slip potentially. They might have product lines that have actually become unprofitable. They're having to re-engineer their business. And when you get to decline, sort of obvious again, that's where the business is struggling to figure out whether they can even survive. And here you're down to over a negative 9% of a negative return on capital, i. e. they're losing money. Sales growth can still be growing, but they're really struggling to maintain margins and a lot of times they're no longer profitable. 

And then debt to equity, these numbers are all relatively close. Introduction phase, growth, maturity, they all are around 19% debt to equity is what they average. These are numbers that long term, they're sustainable, and companies are being somewhat cautious as they grow. They don't want to put too much debt on the balance sheet and potentially inhibit the growth. And usually startup companies don't use debt unless it's a last resort. Shakeout, debt starts going up, it's 25% debt to equity. And then the decline phase, it drops back down a little bit, 21%. But that's usually because you're just getting into a lot of restructuring, maybe even a bankruptcy where they actually just write some debt off. So these numbers are not dramatically different, but the point that we're really going to get into later is that as a company makes more money, they tend to start borrowing. 

A key point that really comes out is cost of equity. For the S& P 500 as a whole, cost of equity is figured to be about 10%, which is the long term growth rate of the equity market. So what happens is, cost of equity capital is lowest at the maturity stage. And it makes sense. Here, you've got more predictability, investors are willing to loan money because they have usually good margins, they have brands, they have moats, they have simply a mature business where they've shown success, they show stability. I'll just use a Coca Cola, PepsiCo, Procter Gamble. Names that have been around for a long time. One of the ones that we've talked about is Hershey. It's a hundred year old business. The market is willing to loan them money at a lower rate. So that lower cost of capital helps to really have a significant impact on what your investment is going to earn. 

But what happens is because these companies, when they reach maturity, they have lower cost of capital. Lo and behold, these CEOs realize, and it doesn't take much that, “Hey, we've got access to the capital markets. We've got relatively cheap financing. So let's go out and buy something.” The problem with a lot of these companies, why they transition from maturity to in this case, shake out or decline is because they overuse debt, trying to create corporate empire. 

So that was the article from Morgan Stanley. And the key point is these numbers on the surface don't seem to match up because as a rule, investors love sales growth. As a company matures, they slow down, but there's always a trade off in the investment world. Yeah, they're not growing as fast, but the profitability is much higher and that allows for dividend returns. There's enough growth there that they can still produce extremely attractive returns to shareholders. 

So now let's get into something that is definitely more concrete and gives you a better idea of why this is really important. We're going to talk about a piece that Damodaran put together. I think he just does a great job of really going through this whole intellectual process and how it can make sense from an investment standpoint. And one thing he does different than the Morgan Stanley article is instead of five segments, he has six. He starts out with: startup, young growth, high growth, mature growth, the mature stable phase, and then the decline phase. So, they're roughly the same concepts, he just puts a little more emphasis and breaks it up into a little more detail. 

You might say, well, you know, how do you determine where a company is? The first thing that he suggests to consider is just the corporate age. Hershey's a hundred years old. Clorox is a hundred years old. Facebook is just a couple of decades old. It's the first place where you start, but all these different companies age at different rates. They have different risks to their life cycles, and this kind of feeds into his industry group and sector look as far as how that affects the corporate life cycle. If the industry as a whole tends to age relatively quick and your company is starting to get out there a little bit and age, t's probably a yellow flag at the minimum that, “Hey, you know, you better start paying attention to what management is doing.”

Some of these companies like technology, they tend to ramp up much, much faster, then it plateaus and they potentially can go into decline at just an extremely fast rate. His comment is tech companies tend to age in dog years. Motorola was a big name for years, basically dominated that market and then it went away extremely fast. Nokia came in, Blackberry came in, there was a company called Apple. If you don't remember those names, depending on how old you are, that's just proof how things can change and how fast they can change. 

Ultimately, life cycles for companies, according to Damodaran, they basically have three dimensions. It's length, the longevity in their life cycles. The height, which is how big the company can get. The slope, which is how fast. You look at a Facebook or Amazon, in just a couple of decades they go from nothing to being some of the most valuable companies in the world. 

Oo, what I will do is give you a quick example of what I think fits each category. In the first stage, the startup, it's pretty obvious. These are companies that are coming up with ideas, getting financing and bringing it to market. The great concepts— people are paying a lot and the ramp up of revenue is going from zero to starting to become a real business that's financeable in a relatively short period. They're very seldom public at this point. It's mostly all venture capital. The average investor just doesn't have access to this space. 

Then we move into the young growth phase and I think a great example is Rivian. This company is actually public, but I will tell you, in the past, some of these really young companies would have been more of a startup venture capital scenario as they continue to build the business plan and to show it's sustainable. They're able to come to market faster because the electric car segment has had so much publicity. But in 2021, Rivian's revenue was $55 million. In 2022, it was $1.65 billion. And then in 2023, it was $4.4 billion. So, you've just had a huge ramp up here in revenue. Of course, they have yet to make any money. In fact, as they ramp up, a lot of times these companies continue to lose more money just because it takes a lot of money to scale up, build manufacturing or whatever they're doing. Now, here's a fascinating thing. Obviously what is true for Rivian is not true for everybody. But if if I told you I have a company that's going to go from $55 million to $4.4 billion in revenue in two years, probably your first reaction would be: “Can I bet the farm and put everything I have into it? Because this is going to be a great investment.” Well, you no longer own a farm because the stock was $180 in 2021. It dropped all the way to less than $50 in 2022. And then last year, the stock hit $10, which is basically where it lives now. So, the first point is in the corporate life cycle, being in early is not always a good thing. 

Now we go to the high growth phase. Here, I'm going to use Nvidia. It's probably not the best example for this because Nvidia does have some maturity in it and they are profitable, but they're still growing extremely fast and the dividend yield is basically zero. They're really using a lot of their capital to continue to ramp up their business. 

We're going to use Microsoft for mature growth. The company is actually still growing at more than 10% a year, which for a business that is as large as Microsoft's— which happens to be, they trade off it seems like every other day, but Microsoft is either number one, two or three most valuable companies in the world. So usually when you hit that kind of scale, growth has slowed down because it's the law of large numbers. But Microsoft still continues to grow at higher than a 10% rate and their margins continue to be extremely high. That's really more of what mature growth looks like. 

Then we get to mature stable. This one I think is pretty easy. I'm going to use PepsiCo. The business is extremely stable. It's not growing by much, but it does grow. The earnings are growing over time and they continue to have a 7%+ growth in their dividend rate. The good news is when you have a mature stable business, it kind of goes back to the runway where maturity is the longest because they have built great brands, they've got patents, they've got something that helps to create a moat, and a lot of times it's fairly wide, and it's extremely hard to penetrate. 

And then in decline, there's a lot of different ways you can look at this. Just briefly, we've mentioned Philip Morris in the past, where you've got the industry that's declining, but they manage the business and the cash flow well, and it's created wealth for shareholders. But here I'm going to use GE. It's been around for more than a hundred years and what happened is the company was basically broke up to help it survive. With GE right now, the pieces were broken up between the aviation sector, the medical piece, and then the third one is for utilities. Even though GE hit the decline phase in a big way in the last decade, it's showing signs that it successfully reinvented itself. Again, just because a company is in a certain phase of a life cycle, it could still be a great investment. 

So now we're going to go through some different illustrations of kind of how Companies react to these different stages or what their policies are. Partly to save time and to help try to limit confusion from this point on, I'm not even going to really mention startup at all. Not to say that it's not worth looking at the startup or young growth phase. We have no interest there because there's virtually no dividend in that space. They can't even afford a dividend, even if they wanted to. But as dividend investors, the high growth, mature growth, mature stable— here is where it becomes fairly important. 

And as you get into the high growth phase, it's still probably more equity funding, but as a rule, they've begun to have positive cash flow. The company is still probably using it to fund growth, and they're just not at a point where they want to pay out any dividends yet. As we move into the mature growth phase, here's where companies can a lot of times start to pay dividends and it's where the dividend growth is usually the fastest. But we don't do hardly anything here because we're not interested in these quarter 1% dividend payouts or less. Even though the dividend may be growing 10, 20, maybe even 50% a year, we want more of the cash flow because we're trying to find a lifestyle. Damodaran points out that here, debt capacity really starts to increase and it's simply because they're adding new products. They're trying to augment product lines that have become successful. Cash is starting to build up, they're profitable, and now they can start using debt to leverage the business to increase returns to the equity holders. This is where the problems start to potentially come in. 

When you get to the mature stable phase, companies have a lot of access to debt and the cost of equity is the lowest. They're usually the most profitable. They have more cashflow then what they need. They have plenty of cashflow to fund growth and they can actually pay off debt if they choose to. This is where you get into some great dividend income and you still have growth because these companies are still growing at 5%. In some previous podcasts, we call that GDP or GDP plus growth. I mean, it's enough to create some great wealth for shareholders if you hold it long enough and they've got long runways (as we mentioned earlier, 15 years). That is exactly what we want to get that 7% or more dividend growth and they have the cash to do it. So where we really live is between the mature growth and mature stable phase. 

Here is the big problem. A lot of times CEOs will go out and try to make acquisitions to keep throwing growth into the picture. But if you've read the studies on acquisitions, they hardly ever work and they almost always destroy shareholder value over time. It's amazing that people are so pro acquisition and there's so many of them that occur, but this is where you have to be really careful because you're starting to get into the good dividend yields where you're getting two, three, 4%. They're growing at the rate of the S and P 500. Earnings grow at about 6% a year. Dividends grow at 6 to 7% a year. So you've got good cashflow. You've got good dividend growth. But this is where the seeds are sown, where the sustainability of that starts to come in to question. Just look at AT& T. I mean, they've made some huge acquisitions in the past. They bought Time Warner and they spent a ton of money on a business that was very predictable, lots of cashflow. Then cable went into decline and it got to the point where the dividend growth almost became non-existent. So you really have to pay attention to what's going on. 

Finally, the decline phase is sort of exactly what it says. Decline is not always a bad thing. What happens is usually they're reducing capacity. They're potentially paying off debt either through asset sales, which is what AT& T has just been going through, or they're just trying to manage a long term declining cashflow. They could still have some sales growth, but the margins are deteriorating. They may no longer profitable because of competition. In AT& T's case, at one point, AT& T had more debt than some countries. They had to basically restructure and hey had to spin off some of these businesses. They cut the dividend and now they're trying to reinvent and refocus the business. But if you have a good manager, they can actually do quite well. GE split up, we used that one as an example. Tobacco continues to be a shrinking market, but Philip Morris's management has done a great job of managing that decline. Companies that are managed well, no matter where they're at, can still be great investments. So we'll leave that there. 

Then the next way he kind of categorizes these is when you're in the earlier phases of a company's growth, as they really start to develop the story, what is important is pretty much all narrative. That's all they have and that's what they're selling and that's what they're getting investors to buy. In the startup phase it's “Well, how big can this be?” Then as you get to the young growth stage, it's more about, “Well, okay, how plausible is this story?” Well, when you get to the high growth stage, it's still narrative, but numbers begin to make a little bit of difference. I think the great story here is Tesla. It's not a dividend stock, but Elon Musk has been a master at narratives, sticking to the story, no matter what. And even though he would say a product line was going to come out in the next six months or 12 months, and he was always late, he never deviated from the story. 

As you get to the mature growth stage, it now becomes much more about numbers but there's still a narrative to the story because people or investors are still pricing in growth. Microsoft is one of the more profitable companies out there from a standpoint of total cash they generate, but there's still a great story. The big one right now is AI and the stock has a higher valuation partly just because of that. 

When you get into the mature stable, it's all numbers. What do you pay? What kind of cash are they returning to me? It's not really about growth. It's just about maintaining GDP type growth. And this is the part I think that trips up most all investors, because you get enamored by growth or you just think you have to have growth or you can lose patience as there's a challenge here and there. When you get into the stable growth it takes time. It's all about compounding, but you make fewer mistakes because there's just more stability there and it's more predictable. And as long as you pay attention to what you pay for them, you can create some tremendous shareholder wealth. 

When you get into decline, it is all numbers and what you pay for it and are you able to buy an asset cheaper than what the market is pricing it at? Just because the market says this is actually potentially going away and the business isn't worth anything, there are still assets underneath this. If you can buy it cheap enough, you can still make money there.

A couple points too on this, at the beginning when you're really leaning on narrative, there really are no constraints. I mean anything is possible. The market will throw just unlimited amounts of money at these things, it's kind of amazing. As they become less narrative and more about numbers, you actually get more and more constraints on the business. If PepsiCo came out with a new drink tomorrow, what's it going to do, move growth by 1-2%? It's really all about the numbers there. The story just isn't driving much of anything. 

So now for the next part of this, we're going to go into pricing. When you're in the early phase, it's all about price. People are pricing stories, there's really no value there. There's a huge difference between market value and the asset base below it. In this space, it's mostly all traders. That drives the volatility of the stock— little news events on the story, or just what's happening in the broad marketplace in general can affect how these traders react every day. 

As we get to the high growth, mature growth and mature stable area, we've transitioned the income statement all the way down from looking at the very top of it to the very bottom of it. Now it becomes: we're going to value this thing based on what we think of the earnings growth. Now you're looking at PE ratios. You're looking at price-to-growth. You could still have some traders that are in there trying to make a small profit on a move on or something, that potentially is always the case. But here it's really more of an investor base that’s based on long term investing.

And then as you get the mature stable, it's all about earnings stability. What do you pay for that stability? It's almost all value. You can't say this as a general rule, but they tend to decline less when the market declines but they also tend to not go up as fast when you get into a huge market moves in a relatively short period of time. If you're going to focus on dividends, that tends to be a much more sticky investor base. You've got a whole different mindset. You're not really focused on the month to month, quarter to quarter returns. You're much more in total return. How am I able to maximize compounding my cash flow? 

But the decline cycle is pretty much all driven by pricing. And what that means is you have a book value and what are they worth in liquidation? The activists live here, they're trying to arbitrage something, and we spend very little, if any time there, unless we just view something as a real opportunity.

So we're going to wrap this up with why I think it's extremely important to keep this in mind. It really drives the bus. All the other things we've talked about so far has been about why they're valued differently or how they can potentially perform, but it comes down to: How can we help protect a long term dividend growth story? How are we going to get the dividend growth and what are the signs we need to look for? And here, we're going to talk about how CEOs fit in to each of these sectors. 

So in the early stages, it's a CEO that has a great vision and is able to handle situations where the story looks like it's a jeopardy or it's being challenged, but they're able to continue to convince people, that down the road there's going to be a ton of value that we're going to create. 

Well, when you get into the high growth part, then you get into a CEO that is somebody who can execute this story. They're managing supply chains. They're looking at financing. It's a CEO able to manage a lot of moving pieces. 

As you get to the mature growth stage, it's a CEO that's all about quality of growth and maintaining the growth. Damodaran uses the term: “Keep the story in sync with the numbers.” 

In the mature stable phase, it's a CEO that adjusts the story to reflect the maturity. Here, the story is changing. The marketplace is competitive and they're attacking pieces of your business. You need to be the CEO who is the defender, who's trying to protect the business. They can adjust the story as they run into challenges. And then he makes the comment, the CFO's role is just say, “no,” because as I mentioned earlier, you've got the ability to acquire. The easy answer is: “Let's go out and let's buy growth.” But that's where all the problems can either start or just continue— trying to solve their problem by buying their way out of it. Maybe it affects their bonuses or it affects their stock options, but this jeopardizes the long term growth of the dividend. 

When we get to the final stage of decline, you want a CEO who can effectively manage liquidation and try to figure out how is the best way to get the most value out of the assets that we own. 

One of the things to just keep in mind, and Damodaran brings this out, it's looking for consistency and looking for mismatches in corporate culture. As they transition, these mismatch stories at the beginning are less important because you've got the CEO that has shown some ability to grow and to tell a story. Most all of them are pretty good at telling stories. As a company matures the impact of a mismatch of a CEO can go up dramatically, even to a point where it can be catastrophic. 

These things can change from one life cycle stage to another. They can reinvent themselves, but it's very hard. I can think of a better example longterm than IBM. It was just a phenomenal grower in the middle of last century, it ran for decades. It had mature growth, and then it's been through a few decline moments. And then lo and behold, just in the last year, it's shown signs that maybe they found a new pathway to growth again. Microsoft— back around 2004, 2005, and 2006, it was all about Apple. “Okay, they're not going to die tomorrow, but who wants to live here?” The stock was $23, and guess what? Intel— I don't think it's going to die, but clearly the decline stage has been brutal for it and we'll see how that one plays out. 

So, to conclude, you may ask: “All right, so just tell me point blank, what's your point?” Damodaran will make the comment that you should really invest across all of these lifecycle stages. And I would actually on some level say, I have no problem with that. We never make the statement that you should put all your money in dividend growth, but we do believe in the core of that concept and there's nothing wrong with having some things outside of it. We live in the mature growth to mature stable phase, because that gives us what we need. You have a long runway there. You've got profitability. It's never easy, but it becomes easier to predict what the dividend growth is and how a company is going to continue to grow it. Also, it becomes somewhat easier to see if a company is doing something that could put the dividend at risk. These life cycles can impact your cash flow, it's just something that's extremely important to keep in mind. There's a lot of moving parts and you have to reconcile them and understand the risk you're taking and what the payoff is going to be and what can change that payoff. We don't want to take more risk than we have to. We're trying to keep all the factors we mentioned earlier in mind as to how we're going to protect the Dividend Growth Story. 

If you enjoyed today's podcast, please leave us a review and subscribe. If you would like more information regarding dividend growth or our investment strategy, please visit growmydollar.com. There you will find previous episodes and also our monthly newsletter. If you have any questions or anything to add to today's episode, please email Ethan@growmydollar.com. 

Past performance does not guarantee future results. Every investor should consider whether an investment strategy is right for them and all the risk involved. Stocks, including dividend stocks, are volatile and can lose money. Denewiler Capital Management may or may not have positions in the publicly traded companies mentioned herein.