The World Has Changed: What do Investors Expect Now From Growth Stories?
Read InspIR’s views below and join our webinar on Thursday, July 21, 2022 at 11:00 AM EST to hear the views of leading GEM equity and fixed income investors. Register here.
Companies must acknowledge investor concerns in today’s uncertain and rapidly changing market environment and quickly adapt their actions and communications.
The drop in economic activity caused by the onset of the COVID-19 pandemic in early 2020 was immediately followed by a rapid rebound in 2021. Growth investors favored equities of companies reporting skyrocketing sales and market capture, with less attention to current profitability. Companies in this growth-focused climate readily used their excess liquidity to capture new customers and close M&A deals.
IROs and management teams responded accordingly, emphasizing growth metrics and opportunities to scale their businesses and expand market share. Investor communications in the tech industry, for example, were dominated by terms such as total addressable market (TAM), number of downloads, and total subscribers. Equities were popular among both institutional investors and a quickly growing retail investor population, capturing greater attention than fixed-income alternatives.
Now, a year later, the world has changed. Rampant inflation reached a forty-year high, which the Federal Reserve intends to combat by increasing interest rates. The first quarter of 2022 recorded an annualized 1.6% decrease in real GDP and a 2.2% year-on-year decrease in profits in the U.S. The inversion of the U.S. Treasury yield curve forbodes recession, and prominent figures such as JP Morgan CEO Jamie Dimon warn of impending economic turmoil.
In the wake of recent pessimism, uncertainty and approaching second quarter results, what are investors looking for?
First, investors want to see a greater focus on profitability or a clearly articulated path to profitability. Last year’s emphasis on growth has changed to a focus on profitability, even among the most bullish of growth investors. The positive attention previously garnered by companies investing in technology and scalability to generate long-term profitability is diminishing in favor of established, fully scaled companies that are already positioned to generate profits. Although growth investors traditionally placed less value on short-term profitability, today they are looking for growth companies that can also demonstrate resiliency through the current market uncertainty. If yet unprofitable, the market expects growth companies to communicate a clear path to profitability or to take a cautious approach to growth. Yesteryear’s growth investors who sought companies with explosive sales growth are now far more focused on profitability metrics such as price-to-earnings and operating margin. Also in the spotlight is elasticity of revenue with respect to both of revenue to lower liquidity and higher interest rates. A trending rule of thumb among investors is the “rule of forty” – that is, the sum of a company’s revenue growth rate and profit margin should exceed forty. This environment can be expected to remain for a few years, so proactive companies should consider reporting more metrics that showcase their profitability and efficiency now.
For growth companies, this opportunity to emphasize profitability in investor communications must be executed in tandem with a continued emphasis on growth. Growth is important to long-only investors who prioritize profitability in the long term. Long-only investors are particularly valuable as they are agnostic to the current swings of the present market volatility. The merit of the business plan and strength of the management team remain key elements sought by long-only investors. If the growing company hasn’t yet generated profits, it is especially important to articulate a clear path to profitability to provide confidence that it will remain solvent through the current market volatility. Clarity in disclosure and the path to profitability are additionally of paramount importance because the lack thereof can feed price volatility. Volatility invites short-term, speculative trading such as short-selling, which can further fuel volatility in an already unstable market.
Second, investors are looking for strong management teams that communicate their awareness of the weakening macro conditions and demonstrate strategic flexibility. Investors value management teams with the ability to recognize these macro changes and pivot their strategy to best position their companies for success in the near term. Managements that are grounded in the reality of today’s world stand to retain investors who can provide price support as well as attract new investors’ attention.
IROs and management teams should be hyper-aware of the signals they may send to investors via the topics they discuss in their earnings calls and presentations. A message track that continues to prioritize growth metrics as opposed to actual revenue and profit levels as quarter highlights, for example, implies a failure to recognize and adapt to the new reality of current and expected economic conditions. While consistency in the reporting of operating metrics remains expected, giving investors the explicit confidence that management is grounded in reality is essential.
Third, investors are watching company spending and investment choices more closely. Another trend we foresee is that companies that have already invested heavily in their business over the past year are better positioned to succeed in today’s environment. From a capital allocation perspective, investors are more conservative than before and view every expenditure with greater scrutiny.
Similarly, companies that accumulated substantial debt to remain solvent through the COVID-19 pandemic are best positioned if they used the economic rebound of the past year to restructure that debt to improve their maturity profile and lower their financing costs. In 2020, there were frequent bankruptcies among oil companies that failed to adjust to negative demand shocks resulting from the pandemic. If companies are too slow to restructure their debt today, they may face a similar fate.
Companies that have a strong balance sheet are well positioned to make acquisitions, particularly given the drop in valuations. Companies planning to utilize accumulated cash must be aware of the importance of articulating how their spending and investments will translate into profitability in the short and long term, as every action the company takes in today’s environment will be judged with greater scrutiny by investors. This means that precise articulation of how the investment strengthens the core business is more important than ever. The key is prudence: They must carefully and fully articulate how their uses of cash strengthen the core business, fit their long-term core goals, and will drive profitability. How will M&A plans achieve synergies and generate greater profitability? Companies should emphasize actions they have taken to bolster their core strategy in these trying times and make clear that their focus is pivoting to adapt to macro changes. While doing so, it is imperative that management highlights specific decisions made to mitigate potential headwinds stemming from the current market volatility. Statements should focus on the present and near future to acknowledge investors’ concerns about the current macro environment and clearly explain how actionable plans will steer the core business toward profit.
Lastly, ESG performance continues to be increasingly important to investors. Fixed income investors are looking to companies to bolster their commitments in ESG, tying funding decisions to achieving at least the minimum standards of ESG frameworks. Companies that haven’t already directed their resources toward effective ESG performance are behind. Despite the drastic changes in the market since 2021, ESG has remained a priority for investors. Availability of financing is greater for ESG-friendly companies, with ESG funds growing to $2.7 trillion this spring, a 38% increase over the past year. In an environment where money is tight and interest rates are rising, sources of financing at favorable terms are more important than ever to remain adequately funded and minimize the cost of capital. Ignoring ESG narrows the window for capital raising and it will be imperative for success in raising both equity and debt capital.
Investors have adapted their thinking in this context of change, and companies seeking to successfully attract them in this new context must readily do the same.
To learn how InspIR Group can help you enhance your communication with and attract investors call or email us.
Monique Skruzny, New York – monique@inspirgroup.com,+1 212.661.2243
Priscila Nannetti, São Paulo – priscila@inspirgroup.com, +55 11 96586.9310
