Growth Rates and Horizontal Analysis

Revenue/Earnings Growth Rate

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The formula to calculate a growth rate is (Final Value - Initial Value) / (Initial Value). Subtracting one from this value gives us the percent change from the time of the initial value to the time of the final value. For a company’s revenue and earnings, we want to see the 5-year growth rate be greater than 4% per year (~21.7% over five years). However, as always, it’s important to identify the reasons behind a company’s growth rate. For example, if a company’s revenue/earnings growth is negative, we may ask ourselves whether or not the reason for this is something like declining sales or if it’s something like supply chain issues that are affecting the entire industry. Growth rates also provide us with a valuable metric to compare companies with. For example, a company may have had an average annual revenue growth rate of 4.5% over the past five years, but if all of its primary competitors have had an average yearly revenue growth rate of 6%, the 4.5% doesn’t look so good anymore.

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Horizontal Analysis

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Growth rates go hand in hand with horizontal analysis (also known as trend analysis), a commonly used process in evaluating companies. Horizontal analysis is examining how a company’s financial statements change over time. Revenue and earnings are some of the more common metrics used in horizontal analysis, but any component of a company’s financial statements can be used.

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Example of Horizontal Analysis of part of an income statement

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Conclusion

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With growth rates and horizontal analysis, we may identify trends in a company’s performance and make more comparisons with competitors.

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