Super Normal Growth Stock: A Type of Security Explained
Whether you invest in a blue-chip, micro-cap, or startup, each business has a life cycle. Business lifecycle is the evolution of the company in phases over time. It includes the startup, growth, maturity, transition, and stability or decline.
The growth phase may include normal and supernormal growth. This article elaborates on supernormal growth and its namesake stock, the supernormal growth stock.
What is supernormal growth?
Supernormal growth is a phase where a business makes more than average earnings for one year or more. Often, investors use supernormal growth and nonconstant or erratic growth interchangeably. Supernormal growth is a regular part of the industry life cycle.
Typically, supernormal growth outperforms any simultaneous increase in the overall economy. However, the period of supernormal growth is not indefinite. Eventually, competition and market saturation neutralize supernormal growth.
What is a supernormal growth stock?
The supernormal growth stock definition states that it is a stock that experiences escalated growth for a period but eventually returns to average growth. During the supernormal growth period, the security outperforms the market. Hence, identifying and investing in such securities may fetch significant returns to investors. To be considered a supernormal growth stock, the earnings must grow at an extraordinary pace for more than a year.
An example to simplify the supernormal growth stock meaning can include a startup with tremendous demand for a new product. Similarly, future blue-chip companies may experience supernormal growth in the early stages. Most successful companies enjoy supernormal growth at some point during their development. These unusual earnings ultimately stabilize into steady growth over time.
Case Study - Supernormal Growth Stock
A recent case of supernormal growth is Zoom Video Communications. The prices of Zoom rocketed during the
Its cloud-based software enables users to set up video calls. Chat tools are available through the software, and COVID-19 pandemic. users can easily share content. The demand for Zoom increased manifold as businesses adopted a work-from-home model. Remote learning, telemedicine, and social networking also boosted demand.
Before the pandemic, the average price for Zoom was $93.40 per share. In April 2020, the company disclosed that the number of active participants reached 300 million. In October 2020, the price of Zoom peaked at $588.8. Zoom’s earnings also increased proportionately.
However, the revenue for Zoom reduced with the resumption of offices and in-person meetings. Also, Google Meets and Microsoft Teams tapped into the market shortly after. The current market price for Zoom is $109.16.
Similarly, Netflix has a similar life cycle and witnessed supernormal growth in 2017 and 2018. Revenue stabilized from 2019 onwards.
Supernormal Growth Stock Valuation
It is challenging to derive an accurate value for a supernormal growth stock. The supernormal growth stock valuation is not the same as companies with a constant growth rate. It requires a pricing model for average and supernormal growth.
For a stock with average growth, investors use the Gordon Growth Model or the Dividend Discount Model for valuation. The model calculates the intrinsic value as the present value of future dividends. It does not consider market conditions or any change in dividend growth over time.
For supernormal growth stocks, intrinsic value is a function of the company's early high growth years and its later, lower average earnings years. Hence, a two-stage or multi-stage dividend discount model accurately captures the stock value.
Dividend Discount Model with Supernormal Growth
Typically, the intrinsic value of a stock using the dividend discount model is the dividend for the next period by the required rate of return, for example. The expected rate of return is 10%, and the expected dividend is Rs. 1.50 per share. The intrinsic value of the share is Rs. 15.
For companies paying a constant dividend, the value must factor in the history of dividend payment; the economy retains the company's earnings. It is the expected dividend divided by the difference between the required rate of return and the dividend payment rate.
The dividend discount model with supernormal growth factors two stages of dividend payment – average and supernormal.
Supernormal growth: It discounts the higher dividend of the next period to the current period. It considers a supernormal growth rate.
Average growth: It represents the value of a dividend that grows at an average rate. The last period of higher growth helps calculate the remaining dividend's price. However, the expected return is the following year's regular or constant rate dividend.
In case of an abrupt transition between the initial abnormal growth stage and the subsequent steady earning period, the model may be inefficient. The value calculated with the model may be more realistic for a smoother transition to the mature phase. Therefore, analysts use model variations beginning with high growth and linear declines from supernormal to regular periods.
Causes Supernormal Growth in Stocks
The numerous causes for supernormal growth in stocks include:
- Introducing a new product line and technology may accelerate a company's growth
- Creating a dynamic business plan or marketing plan that provides strategic depth
- Improvement in overall service and experience resulting in high volumes
- First-mover advantage from possessing a patent or trademark.
Additionally, general triggers such as a temporary lead in a specific marketplace, macroeconomic factors or groundbreaking technological advancements may induce supernormal growth in stocks. For example, an automobile company may benefit from a reduction in fuel prices.
Identifying security and timing for above-average returns in the equity markets is critical. Supernormal growth stocks yield exponential returns if you have invested at the right time. Hence, investors must be on the lookout for companies that may present supernormal growth opportunities.
Frequently Asked Questions Expand All
Ans. There are various examples of supernormal growth in stocks. Currently, the use of artificial intelligence may lead to supernormal growth in stocks.
Ans. A dividend discount model with supernormal growth is the most appropriate way to value a supernormal growth company.