Today we will be looking at a company’s growth and how we can forecast its expected future growth rate. We will be using the compound annual growth rate formula to calculate the growth rate. I also have a few additional tools we can use to calculate the expected growth of a business in the value investing spreadsheet I created to help me value a business. It is free to download from my website at www.growthwithvalue.com/tools, I have provided a link in the show notes.

The Compound Annual Growth Rate formula is as follows:

CAGR = ((Ending Value)/(Beginning Value))^((1/(Number of Years)) )-1

Where:

Ending Value  = Last published EPS, Dividend or Free Cash Flow figure

Beginning Value = First EPS, Dividend or Free Cash Flow for the chosen period

Number of years  = Number of years between the Beginning Value and the Ending Value.

In summary, we have established that it is important to properly understand the business and its operations to help guide our decision on applying an appropriate rate of growth for the business into the future. We use the Compound Annual Growth Rate formula to calculate the historical growth rate of the business, using either Earnings per Share, Free Cash Flow or dividends, or a mixture of all three, with the result being a good basis to use as the future growth rate of a company. We also understand that the past performance of a business does not always equate to the expected future growth of that business. Again, this is why we need to properly understand the business and the economic environment in which it operates. We also discussed the importance of organic versus inorganic growth and how inorganic growth through acquisitions will provide an unsustainable boost to a company’s earnings. Finally, we discussed two separate growth periods, a high growth period and a terminal or stable growth period. The high growth period is used to apply a higher rate of growth to project the earnings of the business over a given period of time, usually less than 10 years. Terminal growth is a rate of growth usually inline with inflation and is used to calculate the projected earnings of a business into perpetuity, after first accounting for a period of higher growth.