How much should I pay for growth

 

Investors hoping to make a good return may focus on companies that are trading below book value or may be a potential take over target.  However one of the best catalysts for stock price growth is earnings growth.  But how much should you ay?

Using a simple discounted cash flow model we assumed;

-          - EPS growth rates of 5%, 10%, 15%, 20% and 30%

-          - no dividends paid

-          - securities sold in year 5 at a multiple of 14

-          - cost of capital 10%

Based on the assumptions, we estimated the value of stocks based on a multiple of historic earnings;

 

Growth PE Multiple
5 11
10 14
15 17.5
20 21.6
30 32.3

It does appear that a PEG ratio of 1 is a good approximation for growth in excess of 20% while some adjustments need to be made below that.

However, it is a big assumption to believe that current growth rates will persist for 5 years.  Investors should be cautious and understand that if growth falls back to 5% in years 4 and 5 then the multiple reduces to;


GrowthPE Multiple
511
1012.8
1514.6
2016.6
3021
 

 

Risk Disclaimer:  This article does not constitute a recommendation to buy or sell.  Investing in stocks or other securities and derivatives is a high risk activity and not suitable for everyone.  It is advised that individuals should consult with their investment advisor prior to making any investment decisions.  The above report includes information from third party web sites and the author cannot guarantee its accuracy, completeness or timeliness.  It is strongly advised that all readers complete their own thorough research and analysis.

 

Disclosure:  The author holds no positions in any of the above stocks and has no intention to initiate any in the next 72 hours.