There is a common misconception that growth is synonymous with value creation. However, financial analysis shows that growth acts as an amplifier of performance, but that it is not a source of value in itself. The real source of value lies in financial performance, defined as a company’s ability to generate a return on capital employed (ROCE) above its cost of capital (WACC).

The relationship is formalized by the concept of economic profit (or  EVA), which is the difference between the ROCE after tax and the WACC (EP in %), multiplied by the amount of capital invested (EP in $).

• If ROCE > CMPC, the company creates value. In this case, the higher the growth, the higher the Market Value Added (MVA) — which is the discounted sum of future economic profits — will be.
• If the ROCE < CMPC, the company destroys value. In this configuration, growth is destructive: investing more in an unprofitable activity only amplifies the destruction of wealth.

In short, growth is only virtuous if it is profitable. As theorists and practitioners point out, “growth is not a ‘source’ of wealth, but an ‘accelerator’ in the transformation of profitability and value”. A company must first clean up its performance (ROCE > WACC) before seeking to accelerate its growth, otherwise it will destroy value more quickly. This is why the Market-to-Book indicator (Enterprise Value – EV divided by Capital Employed) is positively correlated with the difference between ROCE and WACC: it only exceeds 1 if profitability exceeds the cost of financing (WACC).

However, it should be noted that sales growth can generate economies of scale if fixed costs grow less quickly than revenues. As a result, the total cost per unit decreases, which improves commercial profitability and capital turnover, and therefore ROCE, and therefore performance and value creation.