DCF Terminal growth rate & SGR
I am focusing on my first valuation coursework recently about DCF forecasting. However, I found that I was quite struggling to deal with the terminal growth rate. I am not very sure whether I can use the sustainable growth rate here, namely, ROE*retention rate (assuming the company does not pay out dividends and zero debt level for now and future)?
Additionally, I observed that mostly in the previous years, the SGR was negative, with only one positive SGR in the latest year. On the one hand, the final year SGR is around 12%, which is higher than the required wacc (11%). This indicates that I can not apply 12% as the terminal growth rate for sure. On the other hand, if I just simply take the average of the past years, then the g will be too small and thus leading to a very low stock price valuation. Then, in this case, how can I determine my terminal growth rate?
Hope someone can help me with this problem. I will really appreciate it!
I think you’re approaching this too academically, but then again, I suppose I do not know the context in which you’re doing this for really. From a practitioners point of view, which may or may not be what you’re looking for, the Gordon Growth rate should be around 2-4%. It should be higher than inflation, because if it’s lower then the company with shrivel away. And it should be lower than the GDP growth rate because eventually it would be bigger than the US economy of course. You certainly would not be able to use something like 11-12% like you mentioned in the last year. Also, your last year shouldn’t be growing that fast. It’s unrealistic for a company’s growth rate to fall of a table from the last year of the forecast horizon to get into the LT terminal period. If your company is still projected to be growing that quickly, then I would extend the forecast horizon to give you runway to smooth out and slow down the growth.
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