Calculating assumed growth rate

[Non_Comformist]

Is there a formula which calculates the assumed growth rate based on current price and current earnings?

[BadBoyBenny]

It's not really that simple. I know how to get price given an assumed growth rate and maybe that can be manipulated to give you the answer you need.

What you need is current price, current earnings (or FCF), info about a company's net current assets, and a discount rate. The discount rate should correspond to the amount of risk an investment brings, and is an estimate that may wary from person to person. Some people would use 11 or 10% to see how a company was valued relative to the historic S&P return, some use 15% or higher depending on the company to account for individual company risk.

So then assuming...

Discount rate - <font color="blue"> d </font> (.15 or something like that)
Earnings - <font color="blue"> e </font>
Growth Rate - <font color="blue"> g </font> (.??)
Net Current Assets - <font color="blue"> a </font>

Price (or net present value) should equal something like

year 1 + year 2 ... + year x
P = (e * (1 + g)/(1 + d)) + (e * (1 + g * g)/(1 + d * d))... + a


Some people would use something like 75% of <font color="blue"> a </font> to account for inventory markdowns and uncollectible receivables. They might do it to account for managment not allocating cash ideally too.

You can do it with steadily declining growth rates or lower the growth rate to a terminal growth rate after a certain amount of years. Eventually the growth rate getting lower than the discount rate will make future earnings irrelevant.

I'm not good enough with math to solve this equation for <font color="blue"> g </font> , and it doesn't really work because <font color="blue"> g </font> usually changes throughout time because companies growth slows as they get larger.

Also <font color="blue"> d </font> is a subjective number and the assumed growth rate would change substantially with different analysts' opinions of the riskiness of an investment.

I guess if I was trying to find the estimated growth rate I would plug numbers into this equation with a discount rate I thought was appropriate until I narrowed in on the current price.

quicken.com has an intrinsic value calculator in their stock evaluator that does something similar to this, but it doesn't factor in assets; so a company like Microsoft with several dollars a share in cash always looks overvalued.

Also you can't use assets in valuing a lot of companies like banks, etc. just go by their earnings.

While this equation doesn't always factor in everything you need to value a company, it is really good for making quick estimates and showing you how risk levels and growth rates dramatically change a stock's value.

I remember in finance class this was real easy to do with a financial calculator but I'd have to dig out notes to remember how. If you search on Net Present Value Analysis or Discounted Cash Flow Analysis, you'll probably get a much better explanation.