The short version
- The Boston Consulting Group (BCG) Growth Share Matrix is a tool for analyzing stock investments.
- A cash cow is a business that can generate high amounts of cash flow. An example might be Apple (AAPL).
- A star is a business that has high market share in a fast growing industry. It generates revenues, but still requires significant capital to sustain its growth. An example might be Tesla (TSLA).
- Cash cow stocks could be in your portfolio to provide dividend income while star stocks could be in your portfolio for potential capital appreciation.
The BCG growth share matrix quadrants
The BCG Growth Share Matrix introduces four quadrants:
- Cash cows
- Question marks
- Dogs (sometimes referred to as pets)
We’ll decipher this seemingly random jumble of word salad, starting with the two quadrants that could represent the investments you want the most in your portfolio: cash cows and Stars.
What is a cash cow?
The term cash cow in itself is a reference to dairy cows who are able to continuously provide milk throughout their lives with minimal maintenance. The BCG Growth Share Matrix defines a cash cow as a business that, once profitable, continues to generate high amounts of cash as long as it is in business.
Just like its bovine namesake, a cash cow stock is thought to produce more cash than it consumes. They are often found in mature industries. These companies typically hold a high market share within their specific industry, and require little capital reinvestment once the business has become profitable.
Modern day cash cows could include tech giants like Apple (AAPL) or Microsoft (MSFT). Although tech stocks are still thought of as companies who require high capital reinvestment, both Apple and Microsoft have generated consistent and significant cash flows. A major benefit to this type of stock is that they can potentially continually generate cash flows barring significant disruptions or industry changes.
Cash cow stocks might be the result of a successful star stock in which the industry has matured.
Lastly, cash cow stocks could have the ability to pay dividends with their excess cash flow. For example, both Apple and Microsoft pay dividends even though many tech companies do not have the ability to consistently do so or choose to reinvest their excess cash back into the company. This is because as cash cows, these two companies generate enough excess cash to pay back shareholders.
More: What to look for when buying stocks
What is a star?
A star is another quadrant in the BCG Growth Share Matrix. Stars are companies with a high market share in a fast-growing industry.
Star stocks may generate revenue but also require significant capital to grow their business. This capital is reinvested to continue the company’s growth as an industry leader. The typical goal for a star stock is to become a cash cow stock.
Currently, an example of a star stock would be the electric vehicle maker, Tesla (TSLA). The global electric vehicle sector is certainly a high growth industry and Tesla has a significant share of the market. Though Tesla was profitable as of FY 2021, the Company is still focused on achieving large-scale growth and capturing additional market share.
Cash cow stocks vs. star stocks
Cash cows have captured a large share of the market. Many are now in the phase of the business cycle where they can continuously generate cash flow. A star stock could be aiming to get to this point, but must first establish itself as the industry leader in a mature industry.
Star stocks might not pay dividends or hold share buybacks as frequently as cash cows, since profits that come into star stocks are typically reinvested into the company.
However, star stocks could have higher potential for stock price appreciation compared to cash cow stocks. This might also mean that star stocks have greater price volatility than cash cow stocks, and could result in greater losses of capital.
Whether you choose to invest in cash cow stocks or star stocks will depend on your investment strategy and risk tolerance. Cash cow stocks are more likely to provide dividends, while star stocks could be in your portfolio for potential stock price appreciation.
Therefore, an investor who heavily relies on dividends to provide income might find cash cow stocks more important than star stocks, while a young investor with higher risk tolerance might have a higher percentage of star stocks.
The BCG growth share matrix
The BCG Growth Share Matrix can help provide perspective on how a stock could fit in your portfolio. In addition to cash cows and stars, the BCG Growth Matrix also consists of question marks, and dogs (pets). We already discussed cash cows and stars, but what are the others?
What is a question mark?
A question mark stock is a company that operates with a low market share in a high-growth industry. These companies need to be closely analyzed to see if they're worth maintaining. In a best-case scenario, question marks may eventually turn into stars.
What is a dog (pet)?
A dog, or pet, is a company with a low market share in a maturing industry. Dogs are businesses or products that may be repositioned, divested or liquidated. However, dogs may be kept if they complement other businesses in a company.
The bottom line
The BCG Growth Share Matrix is a useful tool to analyze how a stock could fit in your portfolio. Cash cow stocks could be reliable sources of dividends since they're generally industry leaders in a mature industry and generate significant cash flow.
In contrast, star stocks are usually high-growth companies that could become a market leader in their industry. Star stocks may generate significant revenue, but they usually also need to reinvest capital to continue to grow their business.
Question marks represent businesses that have low market share in high-growth industries, while dogs represent businesses that have low market share in mature industries. It would be important to conduct additional due diligence before investing in stocks that are question marks or dogs as they could be risky investments.
Your investment strategy and risk tolerance will determine the allocation to cash cow stocks and star stocks (or, for that matter, question marks and dogs). Someone with higher risk tolerance might want to focus on star stocks. An investor who relies on dividends for income might be more focused on cash cows.
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