Relative Value of Growth
(Mass)

Analyzing how growth improvement and margin improvement are influencing shareholder value. Explanation of Relative Value of Growth by Nathaniel Mass. ('05)

What is the Relative Value of Growth? Description

The Relative Value of Growth framework (RVG) from Nathaniel J. Mass is a technique that can be used for comparing how growth- and margin improvement effect shareholder value. The relative value of growth expresses the value of an extra percentage point of growth as a multiple of the value of a percentage point increase in a company's operating profit margin. If the multiple is higher, the growth will be more valuable to a company.

An RVG of 3, for example, means that a firm would generate three times as much shareholder value by adding 1% of growth, than it would add by increasing operating profit by 1%.

Mass claims that the shareholder value creation potential of growth strategies often outweighs by a factor that of Cost Cutting strategies. In his article in HBR of April 2005, Mass concludes furthermore that growth is often far more valuable than managers think, especially when considering long-term.

Calculation of the Relative Value of Growth. Formula

RVG is calculated by dividing the value of 1% revenue growth by the value of 1% margin improvement (see fig).

Usage the Relative Value of Growth model. Applications

Making investing decisions.
Corporate Strategy formulation.
Business Strategy formulation.
Establishing a long-term focus.
Show the potential of growth as a source of value.
Understanding shareholders expectations.
Performance Management.
Executive Compensation.

Strengths of the Relative Value of Growth framework. Benefits

Ease of use and simplicity.
Find right balance between growth and margin improvement at corporate level.
Find right balance between growth and margin improvement at SBU level.
Establishing a long-term focus.
Helps to show the potential of growth as a source of value.
Provide managers with an understanding what shareholders expect of them.
Maybe used in the future for Performance Management and Executive Compensation.

Limitations of the Relative Value of Growth method. Disadvantages

Margin calculation is EBIT based / Operating Profit based: limited reliability. Relatively easy to manipulate.
Technically flawed and not very precise:
- DCF model does not distinguish short-term and long-term.
- Cost of capital and growth-return prospects are taken at corporate level.
- No distinction is made between acquisition-driven growth and organic growth.
RVG is a relative measure: does not show the actual amount of the contribution of growth and margin improvement.
RVG helps shifting the investment focus to the long term. However it does not prevent a short-term view by analysts or by investors.
Intangibles valuation?

Assumptions of the Relative Value of Growth model. Conditions

A simplified numeric approach can help to make the right strategic choices and investment decisions
The limited reliability of the Relative Value of Growth formula is not a major problem.