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BCG Matrix for better investment decisions

HomeBCG Matrix for better investment decisions

For the Nth time this year, I will start a page with this – How the share price of a company performs ultimately will depend upon the growth and profitability of the company. Naturally then, before investing in any company, it is almost obligatory that you make yourself aware of the risks and opportunities facing the business. To this end, you must focus on – “The stage of various businesses and products of the company in their respective lifecycles”.

                 BCG Matrix

BCG MatrixFor the credits – BCG matrix was invented by the Boston Consulting Group (BCG) in 1968. The matrix is also known as growth-share matrix. The BCG framework categorizes products within a company’s portfolio as Cash Cows, Stars, Question Marks or Dogs based on their growth rate, market share, and cash flows. 

Cash Cows (low market growth, high market share): These are strong competitive businesses which generate cash surplus (i.e. cash in excess of what is needed to maintain the business). Typically, cash cows have a strong brand recall which allows the company to charge higher prices than its competitors. The excess cash generated could be deployed by the company for dividend payments, debt repayments and in driving future growth in other segments of the company (i.e. in the Question Marks or Stars of the company).

Stars (high market growth, high market share): Stars represent businesses which have a high market share in a fast-growing industry. However, since they operate in a fast paced industry, they require huge amounts of investment to sustain their market leadership. The intention in running such businesses is to turn them into cash cows of the future. Once such businesses sustain their market leadership for a long time, they are more likely to turn into Cash Cows, especially when the economy slows down, if not, they may have to be divested (like Dogs).

Question Marks (high market growth, low market share): Question Marks are businesses which hold a small share in a fast-growing industry. The future performance of these businesses is uncertain. Companies should invest very carefully in Question Marks. If their performance does not live up to the expectations, Question Marks should be reclassified as Dogs and should be divested.

Dogs (low market growth, low market share): These are businesses which have a low market share with no scope for growth. Because these businesses do not hold much economic promise, organization should either not invest in them or sell them as soon as possible.

Case Study:

When analyzing a company for making an investment decision, it is very important to look at the portfolio of products which the company offers. Let’s take the example of a widely diversified company like the ITC Limited which has many businesses and offers a variety of products. The Company’s portfolio of offerings includes cigarettes, FMCG – others, hotels, paperboards and packaging, agribusiness and Information Technology (IT) services. A classification of these businesses would look something like this:

ITC Limited

 How BCG Matrix can help Investors

Whether you are building a portfolio of stocks or you are trying to analyze a particular industry sector or a diversified company, BCG Matrix is a great tool. For example, if you are building a portfolio of stocks, try to classify companies on the basis of the BCG Matrix by drawing the appropriate sign whenever you create a company’s profile.  

Once you start looking at companies as Cash Cows, Stars, Question Marks and Dogs, you will notice that going forward you will always recall more about the company, its businesses and its product offerings. 

 

About the Author

Rajat Sharma pictureRajat Sharma is a well known stock market analyst and commentator. He has covered Indian markets for over a decade and is regarded for consistently identifying early stage investment opportunities. Attorney by qualification, Rajat has done extensive work for improving corporate governance and disclosure standards.