Podcast
Questions and Answers
What is the formula for calculating expected growth rate in earnings per share when ROE is expected to remain unchanged?
What is the formula for calculating expected growth rate in earnings per share when ROE is expected to remain unchanged?
Which of the following correctly uses the given formulas to express return on equity?
Which of the following correctly uses the given formulas to express return on equity?
What was the expected growth rate in earnings per share for Wells Fargo in 2008 based on the provided figures?
What was the expected growth rate in earnings per share for Wells Fargo in 2008 based on the provided figures?
In the context provided, which element is considered a component of Return on Equity?
In the context provided, which element is considered a component of Return on Equity?
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How does the Debt/Equity ratio affect Return on Equity according to the content?
How does the Debt/Equity ratio affect Return on Equity according to the content?
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What primarily drives growth according to sustainable growth equations?
What primarily drives growth according to sustainable growth equations?
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How are marginal returns and sales to capital ratios typically computed?
How are marginal returns and sales to capital ratios typically computed?
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When may marginal values diverge from aggregate values?
When may marginal values diverge from aggregate values?
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What can occur when companies enter new businesses or face changing competition?
What can occur when companies enter new businesses or face changing competition?
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What is the formula for marginal return on capital (ROC)?
What is the formula for marginal return on capital (ROC)?
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What happens to the growth rate when the earnings in the starting period are negative?
What happens to the growth rate when the earnings in the starting period are negative?
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Which method is NOT suggested for estimating growth rates with negative earnings?
Which method is NOT suggested for estimating growth rates with negative earnings?
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Based on Callaway Golf's data, what was the geometric average growth rate?
Based on Callaway Golf's data, what was the geometric average growth rate?
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If net profit continues to grow at the same rate as in the past 6 years, what is the expected net income in 5 years?
If net profit continues to grow at the same rate as in the past 6 years, what is the expected net income in 5 years?
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What is the primary task of analysts regarding stocks?
What is the primary task of analysts regarding stocks?
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What proportion of an analyst's time is typically spent forecasting earnings per share?
What proportion of an analyst's time is typically spent forecasting earnings per share?
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What does it imply when the growth rate is estimated based on negative earnings?
What does it imply when the growth rate is estimated based on negative earnings?
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From the earnings per share estimation context, how reliable are analyst forecasts?
From the earnings per share estimation context, how reliable are analyst forecasts?
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What contributes to the expected growth of a firm?
What contributes to the expected growth of a firm?
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What is the assumed cost of capital mentioned in the content?
What is the assumed cost of capital mentioned in the content?
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Which step is NOT part of the three-step process used when operating income is negative?
Which step is NOT part of the three-step process used when operating income is negative?
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What should be done as the firm grows larger according to the growth estimation steps?
What should be done as the firm grows larger according to the growth estimation steps?
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What is Airbnb’s estimated total addressable market (TAM)?
What is Airbnb’s estimated total addressable market (TAM)?
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Which of the following factors affects the expected operating margins each year?
Which of the following factors affects the expected operating margins each year?
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What is included in Airbnb’s serviceable addressable market (SAM)?
What is included in Airbnb’s serviceable addressable market (SAM)?
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What is the significance of the sales to capital ratio in estimating growth?
What is the significance of the sales to capital ratio in estimating growth?
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What is a potential disadvantage of growth when valuing a company?
What is a potential disadvantage of growth when valuing a company?
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Which method is NOT mentioned as a way to estimate historical growth rates?
Which method is NOT mentioned as a way to estimate historical growth rates?
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What does stable operating income growth typically relate to?
What does stable operating income growth typically relate to?
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When estimating growth, why is the period used in the estimation important?
When estimating growth, why is the period used in the estimation important?
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What is a challenge faced when using historical growth rates?
What is a challenge faced when using historical growth rates?
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In assessing growth, which of the following is NOT considered a fundamental approach?
In assessing growth, which of the following is NOT considered a fundamental approach?
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What is a characteristic of arithmetic versus geometric averages in historical growth estimation?
What is a characteristic of arithmetic versus geometric averages in historical growth estimation?
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What is the primary goal when looking at analysts' estimates for company growth?
What is the primary goal when looking at analysts' estimates for company growth?
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What is the formula for calculating the Reinvestment Rate?
What is the formula for calculating the Reinvestment Rate?
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If a company's Reinvestment Rate increases, what impact does it generally have on expected growth in operating income?
If a company's Reinvestment Rate increases, what impact does it generally have on expected growth in operating income?
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What is the Expected Growth Rate formula when the return on capital is changing?
What is the Expected Growth Rate formula when the return on capital is changing?
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Which of the following concerns is associated with Cisco's forecast when it has a reinvestment rate of 106.81%?
Which of the following concerns is associated with Cisco's forecast when it has a reinvestment rate of 106.81%?
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How does a decreasing return on capital affect the expected growth in operating income?
How does a decreasing return on capital affect the expected growth in operating income?
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What aspect of Cisco's situation might lead an investor to worry about its valuation as a 'star' company?
What aspect of Cisco's situation might lead an investor to worry about its valuation as a 'star' company?
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What implication does a high return on capital have for a company's reinvestment strategy?
What implication does a high return on capital have for a company's reinvestment strategy?
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Why should one be cautious in using sustainable growth equations when return on capital is changing?
Why should one be cautious in using sustainable growth equations when return on capital is changing?
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Study Notes
Estimating Growth
- Growth can be good, bad, or neutral.
- When valuing a company, higher growth is often seen as a positive sign, implying higher value.
- However, growth is a double-edged sword.
- The positive side of growth is that it boosts revenues and operating income.
- The negative side is that reinvestment is necessary to maintain that growth.
- The net effect of growth is whether the good outweighs the bad.
Ways of Estimating Growth in Earnings
- Look at the past: Historical earnings per share growth is a starting point.
- Look at what others are estimating: Analyst estimates for many firms can provide valuable insight.
- Look at fundamentals: For stable margins, operating income growth correlates with reinvestment and returns.
- For changing margins, revenue growth, margin forecasts and reinvestment estimates are needed.
Historical Growth
- Historical growth rates can be calculated in various ways, including arithmetic and geometric averages, and using simple vs. regression models.
- Historical growth rates can be sensitive to the chosen period.
- Using historical growth rates requires addressing issues like negative earnings and scaling effects.
Motorola: Arithmetic vs. Geometric Growth Rates
- Historical data for Motorola's revenues, EBITDA, and EBIT from 1994 to 1999 is provided, illustrating differences between arithmetic and geometric averages and associated standard deviations.
A Test
- A hypothetical example demonstrates the calculation of growth rates in earnings per share, showcasing the difference between growth rates calculated using positive and negative earnings.
Dealing with Negative Earnings
- When starting earnings are negative, growth rates cannot be directly estimated.
- Solutions include using absolute values or a linear regression model instead.
- In the context of negative earnings, the growth rate is often meaningless as an indicator of future performance.
The Effect of Size on Growth: Callaway Golf
- Callaway Golf's net profit and growth rates (1990-1996) are displayed.
- A geometric average growth rate of 102% was calculated.
Extrapolation and Its Dangers
- This section highlights potential pitfalls of extrapolating historical growth rates.
- Example with historical data from Callaway's net income (1996-2001).
Analyst Estimates
- During much of an analyst's time, forecasting earnings per share is a significant part of their job.
- Analyst forecasts are usually better than simple time series models, but differences remain relatively small and often highly correlated across analysts.
Are Some Analysts More Equal Than Others?
- A study of All-America analysts suggests that chosen analysts do not meaningfully differ in forecasting proficiency.
- There is evidence that analysts chosen for All-America analyst teams tend to become slightly better forecasters after being selected.
- Earnings revisions by All-America analysts generally have a greater price impact on stocks.
The Five Deadly Sins of an Analyst
- Avoiding tunnel vision: Focus on the wider picture beyond the sector.
- Avoiding lemmingitis: Resisting unnecessary herd mentality in revisions.
- Avoiding Stockholm Syndrome: Maintaining objective perspectives when evaluating firms' managers.
- Avoiding factophobia: Relying on facts and evidence, not creating or perpetuating "stories."
- Avoiding Jekyll and Hyde Analyst issues: Avoiding the tendency to bring investment banking business to the firm.
Propositions About Analyst Growth Rates
- Proposition 1: Analyst forecasts often overestimate private information.
- Proposition 2: The company itself is a key source of information for analysts.
- Proposition 3: Analyst forecasts can be useful.
Sustainable Growth and Fundamentals
- This is a discussion about how to calculate fundamental growth rates.
- A specific methodology for deriving fundamental growth rates was explored.
Estimating Fundamental Growth from New Investments: Three Variations
- Three methods for deriving growth rates from fundamental data are presented: Method 1: Earnings per share, method 2: Net Income from non-cash assets, method 3: Operating income.
Expected Long Term Growth in EPS
- A formula for deriving expected long-term growth rates in earnings per shares is presented.
- A real world example with Wells Fargo is provided. and a formula that calculates expected growth rate.
One Way to Pump Up ROE: Use More Debt
- Employing more debt can elevate Return on Equity (ROE).
- The example describes this strategy using 1998 Brahma data.
Expected Growth in Net Income from Non-Cash Assets
- A formula to determine a company’s growth of net income from its non-cash assets is presented.
- A specific instance from 2010 Coca-cola is used as an example.
Expected Growth in EBIT and Fundamentals: Stable ROC and Reinvestment Rate
- Defines how to calculate expected growth rates of EBIT when return on capital is steady.
Estimating Growth in Operating Income, if Fundamentals Stay Locked In...
- A hypothetical example of Cisco in 1999 outlines the potential issues with relying on overly optimistic forecasts.
The Magical Number: ROIC (or Any Accounting Return) and Its Limits
- This details the importance of carefully considering the accounting issues that can affect reported operating income.
- The use of return on invested capital (ROIC) is discussed, including life cycle effects and accounting write-offs.
Operating Income Growth When Return on Capital Is Changing
- A formula for expected growth rate in operating income that captures the impact of changing returns on capital is outlined.
The Value of Growth
- A table compares different firms exhibiting diverse reinvestment rates and returns on invested capital.
Top-Down Growth
- Overview of the top-down approach to estimating revenue and operating income growth, suitable for firms facing negative income or changing margins.
Estimating Growth When Operating Income Is Negative or Margins Are Changing
- A three-step process for estimating growth in situations with negative operating income or changing margins.
Revenue Growth
- Detailed process for determining revenue growth, considering factors such as market size, growth, market share and industry economics.
Airbnb: Total Market
- Detailing Airbnb's market potential estimates.
Airbnb: Market Share
- Airbnb's market share strategy.
Target Margins (and Path There)
- Discussing the factors that drive target operating margins
Airbnb in November 2020: Growth and Profitability
- Airbnb's key financial data (November 2020).
Sales to Invested Capital: A Pathway to Estimating Reinvestment
- A practical guide for calculating and analyzing the sales to invested capital ratio.
Airbnb: Reinvestment and Profitability
- Airbnb's reinvestment strategy.
Aggregate Versus Marginal Values
- The distinction between aggregate and marginal values for calculating returns in dynamic environments.
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Description
This quiz explores the multifaceted concept of growth in companies, discussing both its positive and negative aspects. You'll learn how to estimate growth in earnings by analyzing historical data, analyst estimates, and fundamental metrics. Delve into the complexities of growth and its impact on company valuation.
