Company Risk. Let's consider the market's view of a company's future growth prospects. As growth increases and, or margins increase, valuations in terms of multiples increase as well. This happens during a company's growth phase. Risk is still present as the company is relatively new and fighting off both old and new competition. Once the company begins to emerge from that, growth slows and margins stabilize. The riskiness of the stock decreases. Valuations, again, in terms of multiples, begin to decrease as well. What do each of these really mean for business? Let's ignore the numbers for now and try to understand the qualitative drivers of each. We can see the same phenomenon described in the last slide on this company lifecycle graph, which shows the four major time periods of a company: the startup, growth, maturity, and decline. Very few companies in the startup phase are credit worthy as they are all upside, meaning equity and very little cash flow or assets. Growth companies are either looking to IPO or have recently IPOed and are showing cash flow growth that enables them to borrow. These are still high return companies as risks are present. Most companies in the maturity phase are active borrowers, as equity becomes expensive and credit is very affordable. They are also facing steep demands by shareholders to generate value via stock buybacks and dividends. When sales growth is a challenge and margins are fluctuating or declining due to constant restructuring, et cetera, these are warning flags. Brick and mortar retail is a perfect example of this. The key to credit analysis is to recognize when companies are in transition, particularly into decline. The Boston Consulting Group Matrix is helpful for companies or investors looking to prioritize their portfolio. It rewards market leaders by assuming that they achieve cost advantages over competitors. These advantages lead to high growth rates, which in turn lead to high market share and increased market potential. Companies do not necessarily move through this matrix the way they do in the previous slide, the lifecycle graph. Although it is rare that a company that is successful would remain in one quadrant very long. Apple is an example of a company that has actually been through each quadrant. They were a question mark in the early days of home computing to quickly a dog that was left behind by the rise of the IBM platform. Innovation by Steve Jobs made it quickly a question mark again, and then finally the release of the iPod and iPhone catapulted Apple to star, and now nearly a decade later, it is clearly a cash cow. The matrix can also be used to analyze how a company develops its own portfolio of business for growth. Cash from cash cows should be invested in question marks to drive further growth and margins. If a question mark becomes a star, growth and margins are protected and enhanced. Stars attract competition, which will eventually erode margins and limit growth, making them cash cows. Dogs and pets should be divested as soon as possible. Businesses need to continuously innovate if their growth and margins are to be maintained. Conglomeration, however, does not bring true diversity in earnings or cash flow if there is still only one dominant business. Understanding competitive factors is critical. Comparing credit quality to others is necessary to establish company risk. To compare credit qualities, we need to know specifically how companies compete, quality, price, innovation, customer service, convenience, et cetera. Porter's Five Forces examines the rivalry among existing competitors. The threat of new entrants, people doing what you do better. Bargaining power of customers, can prices be raised? The threat of product substitutes, can buyers go somewhere else? The bargaining power of suppliers, are you a price taker or price maker? Walmart, for example, has historically turned suppliers into price takers. The Five Forces works as follows. New entrants erode margins and growth, increasing consumer choice and reducing market share. A small customer base can have a drastic effect on sales. If one of them is lost, it will have a dramatic effect on near-term sales and cash flow. A new product in the market can significantly disrupt an industry, destroying value for those who are slow to react. And finally, if suppliers increase their costs, can this be passed on to customers? Or alternatively, can the company push back on suppliers? When we look at an industry, the qualities we are examining to distinguish companies are diversity, price setter, product quality, execution, management quality, market share, shareholder pressures. This is a list of US food retailers, their credit ratings, which we will discuss in more detail in the module on financial risk. This is a very wide range of retailers here in terms of size and market and many factors go into the credit ratings. However, the higher rated credits and the more successful companies at the top of the list, the Walmarts, Costco, Target, Kroger, have achieved higher scores in the categories on the right.