In this context, by “investors” I mean professional managers of (mostly) other people’s money, that move millions at a time — not retail savers like most of us with thousands in a retirement account.
Investors want predictable returns that match the risk-weighted expectations for the portfolios they manage.
Every type of investor has a certain risk profile and horizon over which want to achieve returns. And that rate of return will always be compared against some benchmark, hurdle rate, or previous high water mark.
Here are some investor type examples, listed in order of decreasing tolerance for volatility:
- Angel investors want to “give back” to early entrepreneurs by providing their money, advice, and time with minimal expectations of financial return
- Venture Capitalists will tolerate writing off 9 investments to get one with a 10x exit
- Private equity partners want 8% IRR in a 6 year horizon
- Retirement plan administrators want “5 real:” that is, 5% annualized growth after adjusting for inflation and foreign currency exchange
In equity investments, return on capital comes from share price appreciation and dividends. Recently share buybacks have become a hot topic, as an alternative means of returning excess earnings to investors (instead of dividends), but let’s leave that aside for now (instead, read what Matt Levine has written about it). The new theory views public markets as a way to return capital to early stage private investors — again, out of scope for this post.
From this point, let’s narrow the scenario: you are a leader at a publicly traded company. With stock that trades on the public markets, you need to know what kind of returns your investors want. Index funds, representing a large share but not the majority of equity investors, want the index, which is an aggregate of the prices of the individual stocks in the index, to rise at some multiple of inflation. Some investors speculate on companies being acquired at a premium. Any “long” investor wants prices to grow over time. For a given P/E ratio, earnings growth gets you price growth. Higher earnings growth, sustained over enough reporting periods to establish a new expectation, can command a higher P/E ratio and therefore a greater rate of return on the same annual earnings growth rate.
Drilling down another level, the best way to achieve earnings growth is through revenue growth at constant margins. I say “the best” because revenue has no practical upper limit for a single company, while cutting costs to grow earnings will eventually run out of costs to cut. Revenue growth at constant margins isn’t easy — it’s the stuff careers are made of, or broken by.
I’m fortunate that my entire career has been devoted helping companies achieve more profitable growth, either as a consultant or manager, in both “old tech” and “new tech” industries. I am constantly learning from my direct experiences and case studies of other businesses. Some industries, like energy, healthcare, and FMCG, require significant capital investment across complex global supply chains. Timing these investments within business cycles, maximizing returns of a capital projects portfolio, and pursuing operational excellence are essential in saturated markets with low levels of consumer loyalty and commoditized offerings.
The tech industry contains a different set of growth challenges with different economics: achieving product/market fit then scaling up investment in sales, marketing, support, and infrastructure. Growing markets, loyal (or fickle) consumers, fierce competition for talent and regulatory uncertainty provide endless alternative scenarios for management teams to evaluate when making decisions.
So, when determining what strategy to execute, what projects and initiatives to fund, and generally where to focus your scarce leadership attention, first understand what your investors want based on their expectations for risk-adjusted returns.
Here are some additional resources that you might find useful:
- David Skok on SaaS economics
- Ben Thompson (stratechery) on Tech’s Two Philosophies
- Dave Kellogg (kellblog) on the Curse of the Megaround
- Cullen Roche (pragcap) on Investor Expectations
- Technology-as-a-Service Playbook by Thomas Lah from TSIA
- Capital projects: white papers from McKinsey and PwC
- Culture of Rapid Improvement by Ray Floyd (energy executive and former client)
- Other books on business and personal growth on my Essential Reading List
Image credit: Tristan Surtel [CC BY-SA 4.0 (https://creativecommons.org/licenses/by-sa/4.0)%5D, from Wikimedia Commons