How to determine FCF growth rate (perpetuity growth method)
How do I calculate a growth rate for free cash flows in the terminal period?
Trending Content - Equity Research Forum
Career Resources
Tie it to the inflation rate ~2% or use the long-term growth rate of the economy, 3% (Assuming you are working on a US company)
I've calculated an implied growth rate of 9.5% for the company I'm valuing. I understand that the growth rate shouldn't exceed GDP growth rate (this is a U.S. company)...however their revenues have been growing at around 20% and management is very optimistic about accelerated earnings in the future. Can this 9.5% growth be justified or do I have to revise my model?
No. If a company grows significantly faster than the region in which it operates, you're assuming that it eventually dominates the whole economy. A 9.5% terminal growth rate for a developed market company is way too high. You either need to use a longer DCF (i.e. pick a terminal year farther out) or assume the company grows faster in the interim but reaches its terminal state sooner.
I'm currently using a 5-year forecast period. I'll try forecasting to 10 years and be very conservative with the numbers and see how that goes.
Aside from your initial suggestions, is there anything else I should look at?
I'm not sure how you're deriving your FCF figures, but keep in mind that terminal growth is driven by ROIC and reinvestment rate, i.e. terminal growth = ROIC * RR . If you're assuming a high terminal growth rate, you are also assuming a high ROIC, high reinvestment rate (low free cash flow), or both. You need to look at each of these assumptions carefully to determine how realistic they are. Most companies don't sustain a high ROIC indefinitely.
I've calculated a terminal growth rate of about 5% using an average of historical ROIC x RR. This results in an implied share price 57% below share price. I do not believe the company (Harmon International Industries Inc) is overvalued seeing as they have been around for a long time and have been generating high growth revenues in recent years.
I calculated my FCF as EBIAT + DA +Stock Based Compensation + Change NWC - CapEx
Quod consequatur illo molestias laborum optio voluptate. Voluptatem omnis ullam error nisi sit voluptatum natus molestias. Ducimus corporis consequuntur corrupti fugit architecto magnam sit. Ea aut qui ut cumque ut minima illum. Impedit exercitationem nihil harum quam quo illum. Doloribus laboriosam et hic. Temporibus eius doloremque aut dolor.
Alias perferendis vel autem aut dolor maxime vero. Unde consequatur nihil molestiae. Amet accusamus perspiciatis amet atque sapiente ad aut.
See All Comments - 100% Free
WSO depends on everyone being able to pitch in when they know something. Unlock with your email and get bonus: 6 financial modeling lessons free ($199 value)
or Unlock with your social account...