Companies in the mature stage of the industry life cycle are en- trenched in the economic mainstream. Their products, brands,
distribution channels, and other aspects of their operations are estab- lished. Many become blue chips. Some become giants in their indus- try. Basic operating characteristics standardize among firms within an industry. Financial positions are more liquid and solidly supported within accepted industry standards.
The markets served are no longer unsaturated. Mature firms must depend on reaching the more marginal customers at competitively low prices, replacing and updating sales to prior customers, and most importantly, sustained general economic growth. Profits are more de- pendent on efficient, low-cost production than on an “any price the market will bear” approach used during the previously unsatiated de- mand of the rapid growth stage. The superior rates of earnings growth of the rapid growth stage decelerate.
The shift to general economic growth as the driving force behind mature stage company sales and profits means expected earnings are more sensitive to business cycle fluctuations. Mature stage companies can no longer plow unaffected through the recession. Their demand and pricing strength is no longer so well supported by the unsaturated market. The loss of a few marginal customers, unable to afford the firm’s product or service because of the recession, adversely affects sales. This marginal loss previously did not matter in the rapid growth stage because companies were not able to supply all demand. Now, as mature stage companies serving a mature market, the loss of the few marginal customers affects their sales and profits.
The demand for mature stage company products or services grows less rapidly. The rate of growth is more affected by the business cycle. Recessions bring slower growth and lower expected earnings. Higher fixed-cost companies, which cannot reduce costs in response to the recession, suffer deeper earnings declines. Higher variable-cost com- panies suffer more sallow declines in expected earnings. General eco- nomic expansions bring faster and higher expected earnings recovery to high fixed-cost than to high variable-cost companies.
Fluctuations in the expected earnings of mature stage companies cause fluctuations in their common stock prices. Expected earnings are no longer in the continuous high-growth rate uptrend of the rapid growth stage. Sales and earnings growth trend down to the general economic growth rate. Recessions or expansions below or above the long-term economic growth trend decelerate or accelerate expected earnings. The degree of change reflects the magnitude of the eco-
nomic cycle. Sharp decelerations or accelerations in expected earnings are unlikely in most mature stage companies.
Change in expected earnings for mature stage companies affects the numerator in the Equation (3) valuation framework. The present value concept remains the same. The rate of change in expected earn- ings directly affects the common stock price. Declining earnings exert downward pressure on the common stock price. Rising earnings exert upward pressure on the common stock price. Conversely a rising re- quired rate of return, particularly interest rates, exerts downward pressure on the common stock price. A falling required rate of return exerts upward pressure on the common stock price. The interaction between the rate of change in expected earnings in the numerator and the rate of change in the required rate of return in the denom- inator of the Equation (3) valuation framework determines the direc- tion and magnitude of the change in the common stock price.
The rate of change in the expected earnings in the numerator rela- tive to the rate of change in the required rate of return in the denomi- nator, particularly interest rates, are distinctly different in the mature stage compared to the rapid growth stage. Mature stage companies’ ex- pected earnings grow less rapidly and fluctuate more in-line with the business cycle. Rapid growth stage companies’ expected earnings, in contrast, grow more rapidly and fluctuate less in-line with the business cycle. Investors expect smaller rates of change in the earnings of ma- ture stage companies. During periods of relatively large interest rate fluctuations, the rate of change in expected earnings for the mature stage companies is less than the rate of change in the interest-rate- driven required rate of return in the denominator of the Equation (3) valuation framework. Again the impact on the common stock price de- pends on the direction and relative rates of change in the numerator and the denominator of the Equation (3) valuation framework.
Investors observe significant impacts on mature stage companies’ common stock prices from both the numerator and the denominator in the Equation (3) valuation framework. In contrast, rapid growth stage companies’ common stock prices are more affected by their overpowering growth in expected earnings. Interest rates have a rel- atively lower rate of change. The rate of change in the Equation (3) valuation framework numerator is greater than the rate of change in the denominator for the rapid growth stage companies. As the in- dustry passes from the rapid growth stage through its shakeout into the mature stage, the relative degree of impact shifts from a
numerator-driven change in expected earnings to a more balanced impact from both numerator and denominator changes in the mature stage.
Risks for mature stage common stock investors arise from the rel- ative changes in expected earnings and interest rates as the economic/ stock price cycle progresses. Mature stage common stocks comprise most of the common stock indexes used to describe “the market.” Their collective, broad-based movements are the market.
At the beginning of a bull market, interest rates remain cyclically low while expected earnings of mature stage companies start to in- crease with economic recovery prospects. Investors gravitate first to these more economically entrenched companies because they are en- visioned as the first to experience regenerated earnings growth as well as the most likely to remain financially solid if the incipient recovery fails to materialize.
The bull market in mature stage company common stock prices continues as long as their expected earnings increase more rapidly than the more laggard increase in interest rates. This is observed in Stages I and II of the economic/stock price cycle.
A bear market for mature stage common stock prices, as reflected in the broad-based common stock indexes, starts when the rate of increase in the expected earnings is less than the rate of increase in interest rates. This is observed throughout Stage III in the economic/ stock price cycle. The bear market continues in Stage IV, the reces- sion phase of the economic/stock price cycle, as long as the rate of decrease in expected earnings is greater than the rate of decrease in interest rates.
Companies progress through the mature stage toward the stable/ declining stage. Expected earnings growth tapers off until stabilizing or declining at the end of the mature stage. Demand for the product or service becomes more rigidly defined and static. The few consol- idated companies in the industry cannot grow the demand. They all suffer declining earnings expectations in recessions. They compete among themselves for market share. The demand for their product or service shrinks as competing products or services erode the static market. The typewriter gives way to the stand alone word processor that, in turn, gives way to the personal computer. The tin can is replaced by the aluminum can. The tramlines give way to the car. The replaced industries decline to their minimum level of existence and may disappear.