tag:blogger.com,1999:blog-8152901575140311047.post5534980003704059594..comments2017-01-16T06:06:36.372-05:00Comments on Musings on Markets: How much is growth worth?Aswath Damodaranhttp://www.blogger.com/profile/12021594649672906878noreply@blogger.comBlogger38125tag:blogger.com,1999:blog-8152901575140311047.post-53200896964014172162016-11-25T02:29:29.996-05:002016-11-25T02:29:29.996-05:00Another concept about your Terminal Value that I d...Another concept about your Terminal Value that I don't understand is that you use Growth = NetInvestment * ROC. The NetInvestment basically equals TotalInvestment subtracted by Depreciation. <br /><br />Conceptually, shouldn't the growth be tied to the Total Investment? The actual amount of new investment the firm makes is the factor that determines the growth. The depreciation from previous CAPEX shouldn't have an effect on new investments. <br /><br />However, maybe the past depreciation is a good indicator of the "maintenance" re-investment a firm needs to make into R&D or CAPEX to sustain the current rate of profits. Maybe the TotalInvestment should be separated into a maintenance portion and a growth investment portion. <br /><br />My concern is that by subtracting depreciation from the Total Investment, the Terminal Value will be underestimated because the actual amount of money being invested will not be given proper weight. Do you think this concern is legitimate?Michael Zhuanghttp://www.blogger.com/profile/15065438337715355788noreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-22703277857786124242016-11-24T10:58:44.663-05:002016-11-24T10:58:44.663-05:00Is there a general equation that calculations valu...Is there a general equation that calculations value based on PE and ROC?<br /><br />Moody's at PE 15 with ROC 30% is obviously worth more than a GM at PE 15 with ROC 10%. But it becomes unclear to me if Moody's PE is 30 and GM PE is 10. Now which is more valuable?<br /><br />Is there a equation to normalize this problem? Michael Zhuanghttp://www.blogger.com/profile/15065438337715355788noreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-64883406503393018222016-08-13T05:11:22.142-04:002016-08-13T05:11:22.142-04:00Dear Aswath, thanks for the post. You mention this...Dear Aswath, thanks for the post. You mention this: "For the firm that generates a return on capital < cost of capital, the PE ratio decreases as growth increases, reflecting value destruction in action. For a firm that generates a return on capital > cost of capital, the PE ratio does increase (the growth premium) as growth increases." How did you come up with this relationship or where is this relationship from or the mechanism by which this relationship comes about?<br />Many thanks in advanceEduardonoreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-53461851894938374582013-12-20T01:05:10.481-05:002013-12-20T01:05:10.481-05:00Yo, an astonishing blog post buddy. Thank you Howe...Yo, an astonishing blog post buddy. Thank you However I am having issue with ur RSS feed. Fail to subscribe. Is there anyone getting similar rss feed trouble? Anybody who knows please respond. Thanks!<br /><a href="http://noriskinvestor.com/" rel="nofollow">neuce county texas tax liens</a><br /><a href="http://noriskinvestor.com/" rel="nofollow">tax forclousures auctions</a><br /><a href="http://noriskinvestor.com/" rel="nofollow">neuce county texas tax liens</a><br />Muhammad Shoaibhttp://www.blogger.com/profile/13451532145728245922noreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-8566106267652838332013-02-28T14:38:11.015-05:002013-02-28T14:38:11.015-05:00The real problem when investing in growth stocks i...The real problem when investing in growth stocks is your not buying growth your buying future expectations. How many companies are their out their that can increase earnings and sales by 20% a year for ten years. Very very few. QUALITY STOCKS UNDER 5 DOLLARShttp://www.zipleaf.us/Companies/The-Manhattan-Calumet-Value-Stock-Hotlinenoreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-2680739823296988482013-01-30T13:42:55.906-05:002013-01-30T13:42:55.906-05:00Thank you for your blog post and spreadsheet. I h...Thank you for your blog post and spreadsheet. I have a couple of observations/questions:<br /><br />1. If you assume that return on capital = cost of capital in perpetuity (beyond the high growth period) then any further growth will create no value, so an equivalent assumption when calculating the terminal value is just to set the perpetuity growth rate to zero and assume no further growth reinvestment.<br /><br />2. Also, if you want to reflect the fact that return on capital is going to be competed down over time because barriers to entry can't be maintained forever, what does that imply for returns on the capital that has been invested during (and prior to) the high growth phase? Aren't you implicitly assuming that capital invested prior to your final period will earn the high initial rate of return into perpetuity? In the spreadsheet it seems as though returns are only competed down on incremental capital invested beyond the high growth phase - i.e. the company seems to enjoy perpetual barriers to entry with respect to certain of its activities (those corresponding to capital invested prior to the final period).<br /><br />Thank you in advance for any follow-up comments you might offer.TFBKAPnoreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-38653987980821747662012-12-05T18:59:27.531-05:002012-12-05T18:59:27.531-05:00Growth stock investing is all about buying future ...Growth stock investing is all about buying future expectations. While value investing is all about buying a company thats worth twenty dollars for just ten dollars. I am not a big fan of growth stock investing. What if I own shares in a high growth company thats currently only really worth twentyfive dollars a share but its trading at fifty dollars a share. Whats going to happen to the price of that stock if the future prospects are severely downgraded by analysts. Say growth of revenue and earnings are projected to decrease from 20% a year to just 8% a years. That stock will sell off like a hot potato. How many companies are their that can grow their earnings and revenues by 20% a year for ten years very few indeed. PENNY STOCK BLOGhttp://www.manhattancalumet.comnoreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-71825897453495541562012-09-17T02:04:23.288-04:002012-09-17T02:04:23.288-04:00This comment has been removed by the author.albert georgehttp://www.blogger.com/profile/03644134494161593090noreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-9922916500145539842012-06-11T11:06:56.698-04:002012-06-11T11:06:56.698-04:00Great post professor! It would be interesting to ...Great post professor! It would be interesting to see the proportion of the S&P 500's or the DJIA's value from growth. I wish I had the time to go through this exercise.Anthonynoreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-57004177807868812892012-06-07T22:08:00.813-04:002012-06-07T22:08:00.813-04:00That works only if all companies in an economy are...That works only if all companies in an economy are stable growth firms. Since some firms are high growth firms, the stable growth firms collectively should grow at a rate less than the growth rate of the economy.Aswath Damodaranhttp://www.blogger.com/profile/12021594649672906878noreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-88589856876303260092012-06-07T19:45:09.882-04:002012-06-07T19:45:09.882-04:00If the stable growth rates of some firms are below...If the stable growth rates of some firms are below the growth rate of the economy,shouldn't the stable growth rates of other firms be slightly above the growth rate of the economy? (Based on law of average)<br /><br />Thanks.Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-26510739471536301722012-06-05T07:18:31.005-04:002012-06-05T07:18:31.005-04:00Thanks for reply. I see what you mean but don'...Thanks for reply. I see what you mean but don't get it exactly right anyway. <br /><br />Again, It would be very helpful if you would want to illustrate further in a simple DCF so one can follow exactly how you're doing :-)<br /><br />If u have enough time, of course.Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-88616181367818238342012-06-04T20:40:55.114-04:002012-06-04T20:40:55.114-04:00Prof Damodaran
The idea of separating value gener...Prof Damodaran<br /><br />The idea of separating value generated by existing assets from value generated from growth assets has also been addressed in another interesting way. Marty Leibowitz and Stan Kogelman wrote a number of papers (which ultimately got collected in a book) which introduced the Franchise Factor Model. This model decomposes the P/E ratio of companies into a value multiple coming from earnings from the existing book of business and a separate value multiple coming from growth assets that are expected to generate returns in excess of the cost of capital. They define the ability to maintain a positive spread to the cost of capital as a company's Franchise Factor, and the ability to identify and deploy growth opportunities that contain this Franchise Factor is called the Growth factor. The FFM makes clear that growth without a franchise or a franchise without growth creates no incremental value (or equivalently, no premium valuation multiple).<br /><br />The other interesting result from the FFM model is that it is not the perpetual growth rate that matters but rather the present value of all future investment opportunities ( as a % of existing investment. Thus the FFM can account for irregular investment opportunities that come along over time.Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-24182502095032793702012-06-04T17:44:38.193-04:002012-06-04T17:44:38.193-04:00Excellent point. I did consider allowing for two d...Excellent point. I did consider allowing for two different costs of capital (it is a simple adjustment to the model) but decided against it in the interests of keeping the inputs under control. Since the excel spreadsheet is an open one, why don't you modify the spreadsheet.<br /><br />As for the prior post, here is why why our numbers may deviate, I think one big factor is what I am assuming about reinvestment. In most DCF valuations, you assume for convenience that growth and reinvestment are contemporaneous. In other words, you assume that you if reinvest 40% and have a return on capital of 20% in year 1, you will have a growth rate of 8% in year 1. In reality, reinvestment has a lagged effect on growth. If you reinvest 20% in year 1, you drive growth in year 2. Thus, I have an upfront reinvestment in time 0 to get growth in year 1 and my reinvestment in my final year of high growth is based upon my stable growth rate.Aswath Damodaranhttp://www.blogger.com/profile/12021594649672906878noreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-5493590278431080582012-06-04T16:59:48.430-04:002012-06-04T16:59:48.430-04:00Prof Damodaran
In your first valuation comparison...Prof Damodaran<br /><br />In your first valuation comparison, you assumed that the cost of capital remains the same when you move from a no-growth scenario to a positive growth scenario. n general that is not a fair assumption because changing a business plan to capture growth when previously a company operated with a no-growth plan usually involves taking on more risk. As a result, the cost of capital should be higher in that case, which would reduce your calculated growth value.Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-40975469743597764292012-06-03T21:06:40.917-04:002012-06-03T21:06:40.917-04:00Hi!
I tried the following inputs in your spread ...Hi!<br /> <br />I tried the following inputs in your spread sheet AND in a spread sheet I made on my own since I too didn’t really follow your calculations in B24 (Value added by future growth):<br /><br />EBIT: 2000<br />Tax rate: 30%<br />NOPLAT 1400<br />Growth: 25%<br />ROC: 30%<br />WACC: 8%<br />Riskfree rate (long term growth): 2%<br />Period length: 10 years<br />Long term ROC = WACC = 8%<br /><br />Based on these input numbers I came up with an intrinsic value of firm of 80 040 in my sheet, whereas your sheet returned a value of 85 044. I also did set up a DCF just to check and this confirmed my number. <br /><br />What I do is that I calculate the total firm value by using the formula of a growing annuity and then add the discounted value of the terminal value. By subtracting the “value of assets in place (1400/0.08 = 17 500) I get the value of future growth (65 540 compared to your (67 544).<br /><br />I’ve been going over the calculations over and over again and can’t seem to find any error which is why I would love to see some further explanations on your calculations, preferably including a DCF.<br /><br />I really like the approach of separating value from growth from value from assets in place. <br /><br />Thank you for a great blog!Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-47349856587176830602012-06-03T16:42:10.335-04:002012-06-03T16:42:10.335-04:00I am assuming that the return on capital = cost of...I am assuming that the return on capital = cost of capital in perpetuity. To earn more than the cost of capital, you have to have barriers to entry and it is tough to maintain those barriers forever. So, the safest assumption in the terminal value is to assume that the return on capital = cost of capital.<br />And I will add a mini-DCF with the detailed cash flows so that the valuation part becomes more transparent.Aswath Damodaranhttp://www.blogger.com/profile/12021594649672906878noreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-72806556888806542732012-06-03T12:31:55.605-04:002012-06-03T12:31:55.605-04:00I think there are some great tips for market, on w...I think there are some great tips for market, on web, just like this article, great stuffviewhttp://mutualfundsadvisor.orgnoreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-58181856753310433132012-06-02T17:45:59.619-04:002012-06-02T17:45:59.619-04:00Dear Damodaran
First, I have realy enjoyed readin...Dear Damodaran<br /><br />First, I have realy enjoyed reading your last post (As always). Yet, I must admit that i didn't understand the formula in cell B24 (Value added by future growth)altough my reverse engeneering was close to your figure. Perhaps adding a "Miniature DCF" alongside the formula would help understanding the buildup of that formula.<br /><br />Regarding your last section of yout formula, you assume that the reinvest ratio should be the risk free rate/cost of capital (B20/B19) - Are you assuming that in the long term the Cost of Capital = Return on Capital? If so, what is the rational behind it?Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-18072137703213139112012-06-02T15:37:49.262-04:002012-06-02T15:37:49.262-04:00And if you are wondering why a firm's growth h...And if you are wondering why a firm's growth has to be less than the growth rate in perpetuity, think about what happens to a firm growing at a rate higher than the growth rate of the economy in perpetuity.Aswath Damodaranhttp://www.blogger.com/profile/12021594649672906878noreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-53439478696053289112012-06-02T15:36:29.696-04:002012-06-02T15:36:29.696-04:00There are only two ways that a terminal value can ...There are only two ways that a terminal value can be negative and they are both in conflict with either mathematics or economics. The first is to set the growth rate higher than the risk free rate, which will make the denominator negative. The second is if you set the ROE or ROC way below the cost of capital, in fact, below your growth rate, in which case your firm is contenting to take projects that destroy value in perpetuity. In either case, the problem is not with the terminal value computation, it is with one of these assumptions.Aswath Damodaranhttp://www.blogger.com/profile/12021594649672906878noreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-3115961427698432802012-06-02T08:57:47.815-04:002012-06-02T08:57:47.815-04:00Thanks for the great post! The table summarizing P...Thanks for the great post! The table summarizing Price of Growth versus Value of Growth is a great tool.Pranav Pratap Singhhttp://www.blogger.com/profile/01893712441478627342noreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-69391355810974305872012-06-02T08:05:51.319-04:002012-06-02T08:05:51.319-04:00Dear Professor :
Thanks for the reply ! Really Ap...Dear Professor :<br /><br />Thanks for the reply ! Really Appreciate you taking time and effort to reply <br /><br />>>>>>>hus, if you let growth in perpetuity become too high, your terminal value will be negative<<<<<<br /><br />Yes. I see that. You have summarized my question in one line!<br /><br /><br />>>>>>and more important, you are violating simple rules in mathematics <<<<<<<<br /><br />Violating rules of mathematics : <br />-----------------------------------<br />I see that the numerator becomes negative. So the result becomes negative !! <br /><br /><br />>>>>>and more important, you are violating simple rules in mathematics and economics<<<<<<<<br /><br />Violating rules of economics : <br />-----------------------------------<br />I can't see where I am violating the rules of economics and IF so which one ? <br /><br />I understand that discounting terminal value or discounting cash flows beyond the growth period is a problem most value investors have to / have tried to grapple with ...... <br /><br />But I can't quite understand why the firm's growth should always be lower than the economy's growth <br /><br />and <br /><br />Why the difference between these should be the best denominator to use ....<br /><br />I'm still hoping you have some *other* great solution to this "terminal value" question <br /><br /><br />regards<br />SubuSubunoreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-53784270337076868382012-06-01T11:47:52.551-04:002012-06-01T11:47:52.551-04:00You have a fundamental problem. The growth rate in...You have a fundamental problem. The growth rate in perpetuity cannot exceed the growth rate in the economy, which in turn should be capped at the risk free rate. Thus, if you let growth in perpetuity become too high, your terminal value will be negative, and more important, you are violating simple rules in mathematics and economics. So, cap your growth at the risk free rate, make reasonable assumptions about ROE in perpetuity and the rest will follow.Aswath Damodaranhttp://www.blogger.com/profile/12021594649672906878noreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-84592381214493527832012-06-01T06:51:00.336-04:002012-06-01T06:51:00.336-04:00Dear Professor
Good day to you.
I am completely...Dear Professor<br /><br />Good day to you. <br /><br />I am completely amazed at your contribution to society. These valuation sheets and podcasts are unparalleled among whatever I have seen on the web. Thanks would be too small a word ! .. Still Thanks a ton <br /><br />1. I have tried to use your valuation model sp sheets and couldn't understand something about the fcfeginzu.xls sp. sheet<br /><br />2. I've sent you a mail at the address on your website ... (yeah the same one with XL sheets and models); I'm taking the liberty of posting the question in brief here, because I am NOT sure if that e mail is valid or if it is spammed / closed <br /><br />3. I decided value the Coal Mining Company, Peabody, listed under the Symbol BTU, using your methods. <br /><br />4. Using your model.xls sheet I arrived at a conclusion to use the FCFE technique / method and so tried to use fcfeginzu.xls sp. sheet, with following parameters <br /><br />5. My problem / doubts are with fcfeginzu.xls and so please ignore para 4 above IF that turns out to be a distraction<br /><br />6. When I use fcfeginzu.xls I see that Cell D 22 on the Sheet titled "Valuation", has the following formula =IF(Inputs!B25=0,D5*(1-D20)*(1+D19)/(D21-D19),MAX(C12:Q12)*(1+D19)*(1-D20)/(D21-D19))<br /><br />7. In this formulae the denominator is always (D21-D19). (only numerator changes based on the outcome / answer to IFs )<br /><br />8. The way I see it, the denominator is always the Cost of Equity in Stable phase (- Less) Growth Rate in Stable Phase <br /><br />9. I feel this formula leads to some un expected consequences<br /><br />9.1. Sample values for BTU (based on certain assumptions ) in fcfeginsu.xls are <br /><br />Cost of equity = 10.3%<br />Net income without interest = $660<br />Growth rate in net income = 14.5%<br />Eq. reinv rate for H Growth = 74.7%<br /><br />Still the price at end of growth phase is -4571 (negative)<br /><br />10. In the example (BTU) with <br />- a positive Net Income and<br />- a growth rate that exceeds cost of equity and<br />- payout ratio @ 25% of earnings and<br />- 0 Stable growth period (meaning it takes the current earnings in cell D5 above ....<br />- I still get a negative price at end of growth phase <br /><br />11. **I can't understand, where I am wrong**<br /><br />12. If I am not messing up something on the sp sheet, I can't understand How a company with a positive earning now, growth around 15% could have a negative value at the end of income stream / growth period <br /><br />13. The negative valuation does not become positive with increasing current earnings or assuming a 5 year stable growth phase or a 10 year stable growth phase , in this model <br /><br />I'm very curious to know what I am missing .... !!!<br /><br />Thanks in adv. and Best regards<br /><br />SubuSubuhttps://twitter.com/#!/ToSubunoreply@blogger.com