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Subject 6. The Growth Phase, Transitional Phase, and Maturity Phase of a Business PDF Download
Constant growth assumption is not realistic for many companies because their performance is influenced by the business cycle. We discussed different stages of the industry cycle before so we focus on patterns of dividend payments here.
1. Growth phase
- Companies enjoy supernormal growth which cannot be sustained in the long-run.
- Free cash flows are often negative because companies invest heavily in expanding operations.
- Very low or zero dividend payments; majority of earnings are retained to finance growth.
2. Transitional phase
- Sales growth, prices and profit margins are declining as a result of intensifying competition in the industry. Earnings growth rates may be still above average but declining towards the growth rate for the overall economy.
- Capital requirements typically decline often resulting in positive free cash flows and increasing dividend payout ratios.
3. Mature phase
- Profit margins have fallen to the average profitability of the economy.
- Companies invest in projects that earn the cost of capital.
- Growth is commensurate with the general economic growth. It is called the mature growth rate.
- Dividend payout is significant.
Obviously, the Gordon growth model is not valid for companies in growth or transitional stage. In these cases, analysts employ different types of models, such as two-stage DDM, three-stage DDM, and spreadsheet modeling.
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