On Wall Street, there’s a group called “smart money.”

The term refers to institutional investors and other finance professionals who typically are more knowledgeable than retail investors. Smart money usually buys before retail investors buy and sells before retail investors sell.

The key to buying low and selling high is, essentially, to buy something before most people buy and to sell before most people sell. Being a first mover thus means that, on average, smart money will tend to buy a stock lower and sell higher than retail investors.

Be the Leader, Not the Follower

What this implies is that to capture the most upside in a stock, it’s important to invest in it before most other investors start to buy it. This could mean being an early mover or it could mean identifying undervalued stocks.

Remember, the stock market is a forward-looking marketplace. Market participants value a stock based on expectations of a company’s future revenue and cash flow. A stock typically makes big moves when new information changes the expectations that are baked into the market price.

Such expectations are in turn influenced by various factors that affect pretty much every business (e.g., interest rates, inflation, GDP growth, etc.), factors that affect the specific company’s industry (e.g., supply chain dynamics, consumer demand, government regulation, etc.) and factors that affect only the company itself (e.g., balance sheet, margins, quality of management, etc.).

Stages of a Company’s Lifecycle

Furthermore, it helps to understand where a company is in its life cycle and how that could affect market expectations. For example, knowing when a company is supposed to be growing and when it’s supposed to be slowing down and comparing that expectation to what the company is actually doing can reveal investing opportunities.

There are five stages: 1) launch, 2) growth, 3) shakeout, 4) maturity, and 5) decline.

Launch: This is the start-up phase. The company has launched and it is trying to become established. Because the company is unproven and thus risk is high, it is usually challenging for the company to obtain debt or equity financing. Investors (e.g., private equity investors, venture capitalists, banks) willing to take a risk will likely be able to get a good deal here.

The risk of failure is the highest at this stage but the potential return is also the highest if the company succeeds. However, a brand-new start up won’t be publicly traded, so regular Joes probably won’t be able to invest in the company at this stage. Still, it helps to keep eyes and ears open for potential future opportunities.

Growth Stages

Growth: The company has gotten off the ground. It has built a foundation and now the focus is on expanding its revenue base by capturing as many customers as possible and investing to grow such as by aggressive marketing, increasing capacity, and hiring more employees. Because it’s reinvesting cash flow from sales back into the business, some growing companies may take a while to become profitable. Sometimes, even cash flow may be negative.

Whether investors find a company attractive will depend on how they evaluate the company’s future trajectory. This stage is typically when a company will seek to go public. And this is where retail investors will be able to get in on the action.

Keep in mind, just because a company launches an initial public offering (IPO), it doesn’t mean the stock will necessarily go to the moon. History is full of failed IPOs. That’s yet another reason why it’s important to analyze a company and not just blindly follow the herd. As Warren Buffett says: “Be fearful when others are greedy, and greedy when others are fearful.”

Shakeout: Sales growth continues but the rate of growth begins to slow. This could be because the company has already captured most of the market, or its success has attracted competition.

At this point the company may begin to pay out a dividend to shareholders. It may seek to prolong growth by attempting to expand into other lines of businesses. It’s important to pay attention to the company’s profits to see how well the company is controlling expenses when sales growth slows.

Beyond Growth

Maturity: In this phase, growth has essentially maxed out. Without a major reform in business, there’s minimal revenue growth—even zero or negative growth. However, if the company has a strong revenue base and good cost control, it can still remain profitable for years. Some continue to generate steady cash flow and pay an attractive dividend to shareholders. Conservative, income-oriented investors can find these types of companies appealing.

Decline: The companies that manage to find ways to rejuvenate actually stave off this stage indefinitely. However, those that fail to do so will eventually enter a stage of declining sales as their products or services become obsolete or as the competition eats into sales. At this end stage, management may have to consider an exit strategy.

For investors, the challenge is to find companies that likely have a long growth runway ahead but also whose shares haven’t already been bid up to overvalued levels. It’s also important to recognize that company lifecycles don’t always linearly follow the order outlined above. Sometimes a company seemingly in the decline stage can turn its fortunes around.

Recall that some 25 years ago Apple (NSDQ: AAPL) was on the brink of bankruptcy. Today it’s one of the largest publicly traded companies in the world. This is where analysis comes into play.

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