Margins vs Growth

Once returns are high enough, the bigger lever is finding places to deploy capital — not squeezing more from what you have.

The default instinct

When a business is underperforming, the playbook is clear: cut costs, improve margins, get more from less. This is the work of turnarounds and operational improvement.

The instinct persists even when the business is healthy. Margins at 18%? Let’s push for 20%. ROIC above cost of capital? Let’s widen the spread further. The logic feels sound — higher returns are always better.

But the maths says otherwise.

When growth creates value

Growth only creates value when you earn more on reinvested capital than investors could earn elsewhere. If your return on capital equals your cost of capital (say, 10%), then every pound reinvested earns exactly what investors require. You’re running to stand still.

The value of growth depends on the spread:

ROIC at cost of capital (10%): Growth adds nothing. You’re reinvesting at the hurdle rate.

ROIC at 16%, growing 5%: Worth about 45% more than the same business with no growth.

ROIC at 22%, growing 8%: Worth four times as much as no growth.

The relationship is non-linear. When returns are high, each percentage point of growth creates disproportionate value. When returns are marginal, growth is a treadmill.

Why the lever flips

The maths works like this: to grow 5% when your ROIC is 16%, you reinvest about 31% of earnings (5 ÷ 16). The rest is free cash flow. And the reinvested portion earns 16% — well above what investors require.

But if you’re already at 18% ROIC, pushing to 20% requires squeezing harder for diminishing gains. The same effort spent finding another place to deploy capital at 18% creates more value.

This is the threshold most operators miss. They keep optimising profitability when they should be hunting for reinvestment opportunities. Margin improvement feels concrete and controllable. Growth feels risky. So they default to what feels safe — and leave value on the table.

The serial acquirer insight

This explains why serial acquirers compound so effectively. Companies like Constellation, Halma, and Heico have solved the reinvestment problem. They’ve built repeatable models for deploying capital at high returns — buying businesses that already earn above cost of capital, then redeploying their cash flows into more of the same.

The CEO’s job at these companies shifts from “improve the machine” to “find more machines.” They’re not squeezing existing businesses for another point of margin. They’re hunting for places to deploy capital at 20%+ returns, knowing that’s where the value multiplies.

Where to deploy

Serial acquirers solve the reinvestment problem through M&A. But that’s not the only option.

Sales and marketing capacity. If your unit economics work, adding salespeople or marketing spend should return above cost of capital. The test: does each incremental pound of sales spend generate more than a pound of gross profit, discounted appropriately? Many high-ROIC businesses under-invest here because growth spend hits the income statement immediately while returns arrive over years.

Product expansion. New products or features that serve your existing customers, using capabilities you already have. The returns are often high because you’re leveraging existing relationships and infrastructure. The risk is building things customers don’t actually want.

Geographic expansion. Taking what works in one market to another. Returns can be strong if the model translates, but the hidden costs — local adaptation, management attention, regulatory complexity — often erode the spread.

Acquisitions. Buying businesses that already earn above cost of capital, then redeploying their cash flows. This is harder than it looks — most acquirers overpay and destroy value. The serial acquirers who make it work have disciplined processes, strict valuation criteria, and decades of pattern recognition.

The honest answer: most businesses have fewer reinvestment opportunities than they think. That’s why so many high-ROIC companies end up returning cash through dividends and buybacks. Finding deployment opportunities at attractive returns is genuinely difficult, which is what makes the companies who’ve figured it out so valuable.

The practice

Know your ROIC. If you can’t calculate your return on invested capital, you can’t know which lever matters more. Get the number, even if it’s rough.

Compare to cost of capital. For most businesses, 8-12% is a reasonable hurdle. If your ROIC is 15%+, you’re past the threshold where growth becomes the bigger lever.

Audit where you’re spending improvement effort. Are you squeezing existing operations for marginal gains, or actively looking for places to deploy capital at similar returns?

Treat reinvestment as a discipline. Serial acquirers don’t stumble into deals — they build pipelines, develop criteria, and hunt continuously. If growth creates more value than optimisation, finding reinvestment opportunities deserves the same rigour you’d give cost reduction.

Accept that growth requires different skills. Margin improvement is analytical and operational. Finding reinvestment opportunities is entrepreneurial and relational. The shift is uncomfortable for operators who’ve built careers on efficiency.

Profitability is the foundation — you can’t compound returns you don’t have. But once returns are healthy, the question changes. The constraint shifts from “how do we improve the machine?” to “where else can we build machines like this?”

Most operators never make that shift. They keep optimising past the point where optimisation creates value.

Connects to Library: ROIC · Compounding

See also: The Constellation Model — A case study in solving the reinvestment problem at scale.