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The value premium of organic growth

By Marc Goedhart and Tim Koller

Beware of letting acquisitions take priority over organic growth.

It’s not surprising that many executives think about growth primarily in terms of acquisitions. For some, opportunities to grow organically are limited, especially in maturing or contracting product markets. Others are drawn to the allure of high-profile deal making, with its virtually instant boost to revenues and often earnings per share as well.

But executives shouldn’t underestimate the power of organic growth. It may take more time and effort to affect a company’s size, but organic growth typically generates more value. A look at the share-price performance of 550 US and European companies over 15 years reveals that for all levels of revenue growth, those with more organic growth generated higher shareholder returns than those whose growth relied more heavily on acquisitions1 (exhibit). The main reason is that companies don’t have to invest as much up front for organic growth.2 In growing through acquisition, companies typically have to pay for the stand-alone value of an acquired business plus a takeover premium. This results in a lower return on invested capital compared with growing organically.

Companies with the most organic growth create more excess shareholder returns than those with the least organic growth.

We often see companies pass up organic-growth opportunities because they take longer to boost earnings than acquisitions do. But, given an option, they should probably tip the balance toward what they can achieve organically.

About the author(s)

Marc Goedhart is a senior expert in McKinsey’s Amsterdam office, and Tim Koller is a partner in the New York office.
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