How did a life cycle begin

The life cycle of companies

The philosophical dispute about the “right” investment approach is as old as investing itself. Should one invest in value stocks or rather in growth stocks? Is the return potential higher in young, high-growth companies or do you earn more money in the long term with companies that have been in the market for many years and have established business models?

We believe that the distinction between value and growth is not important. It is important that companies develop and show the potential to carry out this development over a long period of time. Every company started out small. Even Apple was once a small garage company and has grown to become the largest company in the world.

The phases of the life cycle

Every company has a life cycle that it goes through over many years, provided the business model is successful. We want to shed light on this life cycle here and work out which phase, from our point of view, is the most attractive for entry.

1. Early phase

If companies have developed a new product (or service) that is accepted by customers, the chance of very high sales growth is particularly high. If the initial values ​​are usually still low, large percentage increases are possible in the initial phase. In most cases, however, companies do not earn any money in this phase, but have high expenditures in order to open up their market and finance growth. In contrast, the absolute sales figures are not yet high enough to cover the rising costs.

2. Emerging phase

In the second phase, the companies have reached an absolute level of sales that already allows them to write profits. However, sales growth rates are still high because market penetration is still at an early stage. The high growth rates also enable economies of scale, which lead to increasing profits and margins.

3. Established phase

At some point the high growth potential is exhausted and the percentage growth rates decrease. However, the company is not yet in a phase in which great competition has arisen. Rather, the company still benefits as a leading company in its product area and earns good money as a result. However, the rates of increase also decrease in profit at a high level.

4. Set phase

If the market is even further penetrated, then companies will continue to grow at very low rates. At this stage, other competitors have already entered the market and are ensuring that profit margins are falling. With good products or services, companies will still generate good profits in this phase, but noticeable increases are no longer to be expected.

5. No growth

There is another category of companies. Those who never show significant growth rates and never make significant profits either. Companies in this phase are characterized by the fact that they do not have any products or services that differ significantly from competitive products.

Which phase is the most attractive?

The majority of the companies can be assigned to category 5. Companies without significant growth and with low profits do not promise attractive returns in the long term. The vast majority therefore exclude themselves as a potential investment for us.

According to the Alpha Star investment approach, companies in the 2nd phase are the most interesting. Companies in this phase already have products on the market that have proven that they will be accepted by customers. At the same time, however, no major competition has yet been able to establish itself because the business models have a moat that first has to be overcome. This position allows the company to dynamically increase sales and to convert this into increasing profits.

The interesting thing about this phase of the life cycle is that the risk of these companies is already significantly lower than in phase 1. Because the company already has established products and a customer base. Profits and positive cash flows are also produced. While many companies fail in the early stages, the rate of those companies that run into difficulties in stage 2 is significantly lower.

From our point of view, the combination of growing profits on the one hand and an already established business model on the other is the “sweet spot” for investing in companies. As an investor, this is where you have the greatest chance of excess returns. Even with companies in phase 3, you will usually still be able to achieve returns that are above average compared to the overall market. In this respect, you do not need to sell immediately if you find that a company is moving from phase 2 to phase 3.

How do you find companies in phase 2?

From our point of view, the most attractive companies in phase 2 are characterized by some essential characteristics that almost always appear:

  1. Unique selling points of the products
  2. Little competition
  3. Attractive sales growth
  4. Established products
  5. Solid customer base
  6. Positive profits & cash flows

How long companies stay in phase 2 also depends on how innovative they are. If a company manages to keep bringing new products onto the market and these are correspondingly successful, it can theoretically move into phase 2 over years and decades. In practice, however, there are not too many examples of this. Microsoft is one of the rare examples of this. Over the years, the company has managed to keep increasing sales and profits to a high degree.

One of the essential aspects for a long-lasting phase 2 status is the subject of research and development. The better a company is in the development of new products and the longer it can achieve a lead with them, the longer it will do well above average. When analyzing a company, the investigation of innovation potential therefore plays an important role.

Conclusion

Typically, companies go through a development cycle. Each phase of this cycle is characterized by different characteristics, opportunities and risks. In our view, companies are most interesting in the second phase of the cycle. Here the relationship between a high degree of leeway in development and a manageable risk structure is often in a favorable relationship. This in turn increases the chances of excess returns. That is why we like to invest in companies in this category in the Alpha Star Fund.

Was this article helpful? Please rate:

Author of the post "The life cycle of companies":
Alpha Star Management GmbH

Rating: 4.8 of 5 at 5 ratings

Interested in more details about that Alpha Star equity strategy, personally explained by Fund manager Felix Gode? We are happy to offer you current monthly updates:

Now exclusively for you:
Our investor magazine
and videos of fund management

  • Alpha Star Magazine per month
  • Video report of the fund management per month
  • Important depot updates occasionally

Now Subscribe to updates

Interested in more details about that Alpha Star equity strategy, personally declared by Fund manager Felix Gode? We are happy to offer you current monthly updates:

Now exclusively for you:
Our investor magazine
and videos of fund management

  • Alpha Star Magazine per month
  • Video reports of the fund management
  • Important depot updates occasionally

Now Subscribe to updates