Podcast
Questions and Answers
What is the formula used to calculate the expected growth rate in earnings per share when the current ROE is expected to remain unchanged?
What is the formula used to calculate the expected growth rate in earnings per share when the current ROE is expected to remain unchanged?
In the given example for Wells Fargo, what was the expected growth rate in earnings per share calculated?
In the given example for Wells Fargo, what was the expected growth rate in earnings per share calculated?
Which component does the formula for Return on Equity include?
Which component does the formula for Return on Equity include?
How does using more debt affect Return on Equity according to the content provided?
How does using more debt affect Return on Equity according to the content provided?
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What was the Debt/Equity Ratio for Brahma in 1998?
What was the Debt/Equity Ratio for Brahma in 1998?
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What do marginal returns on capital primarily reflect?
What do marginal returns on capital primarily reflect?
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How can marginal returns and sales to capital ratios be computed?
How can marginal returns and sales to capital ratios be computed?
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What phenomenon may cause marginal values to diverge from aggregate values?
What phenomenon may cause marginal values to diverge from aggregate values?
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What happens to marginal values when companies face changing competitors?
What happens to marginal values when companies face changing competitors?
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Which of the following statements is true about sustainable growth equations?
Which of the following statements is true about sustainable growth equations?
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What is the first solution suggested for estimating growth rate when dealing with negative earnings?
What is the first solution suggested for estimating growth rate when dealing with negative earnings?
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When earnings are negative, what about the growth rate can be said?
When earnings are negative, what about the growth rate can be said?
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What was the geometric average growth rate for Callaway Golf?
What was the geometric average growth rate for Callaway Golf?
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What was the expected net income in 5 years if net profit continued to grow at the same rate as it had in previous years?
What was the expected net income in 5 years if net profit continued to grow at the same rate as it had in previous years?
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What is primarily spent on forecasting earnings per share by analysts?
What is primarily spent on forecasting earnings per share by analysts?
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What was the growth rate for Callaway Golf in 1995?
What was the growth rate for Callaway Golf in 1995?
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In the context of estimating growth rates, when is the growth rate considered 'meaningless'?
In the context of estimating growth rates, when is the growth rate considered 'meaningless'?
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What was the net profit for Callaway Golf in 1993?
What was the net profit for Callaway Golf in 1993?
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Which statement accurately describes the performance of analyst forecasts compared to time series models?
Which statement accurately describes the performance of analyst forecasts compared to time series models?
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What impact does the selection as an All-America Analyst have on subsequent forecasting accuracy?
What impact does the selection as an All-America Analyst have on subsequent forecasting accuracy?
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What is the formula for calculating non-cash net income?
What is the formula for calculating non-cash net income?
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Which factor reduces the advantage of analysts over time series models?
Which factor reduces the advantage of analysts over time series models?
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How do earnings revisions from All-America analysts impact stock prices compared to others?
How do earnings revisions from All-America analysts impact stock prices compared to others?
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Which component is NOT used in the calculation of the Equity Reinvestment Rate?
Which component is NOT used in the calculation of the Equity Reinvestment Rate?
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What is the median forecast error for All-America analysts prior to their selection?
What is the median forecast error for All-America analysts prior to their selection?
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What could happen if the Equity Reinvestment Rate exceeds 100%?
What could happen if the Equity Reinvestment Rate exceeds 100%?
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How is non-cash ROE calculated?
How is non-cash ROE calculated?
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Which trend is observed regarding the correlation of forecasts of growth across analysts?
Which trend is observed regarding the correlation of forecasts of growth across analysts?
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In Coca Cola's 2010 case, what was the non-cash Net Income reported?
In Coca Cola's 2010 case, what was the non-cash Net Income reported?
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What change is observed in the accuracy of analysts over time?
What change is observed in the accuracy of analysts over time?
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What was the median forecast error of other analysts compared to All-America analysts after being chosen?
What was the median forecast error of other analysts compared to All-America analysts after being chosen?
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What was the non-cash book equity for Coca Cola at the end of 2009?
What was the non-cash book equity for Coca Cola at the end of 2009?
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What was the expected growth rate in Coca Cola's non-cash net income?
What was the expected growth rate in Coca Cola's non-cash net income?
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What was the main component contributing to Coca Cola's Equity Reinvestment in 2010?
What was the main component contributing to Coca Cola's Equity Reinvestment in 2010?
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How is the change in earnings calculated when considering existing and new projects?
How is the change in earnings calculated when considering existing and new projects?
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What remains unchanged in the special case where ROI on existing and new projects is equal?
What remains unchanged in the special case where ROI on existing and new projects is equal?
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What formula represents the growth rate in earnings based on reinvestment rate and ROI?
What formula represents the growth rate in earnings based on reinvestment rate and ROI?
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What is the effect of an increase in ROI from 12% to 13% on earnings in the example provided?
What is the effect of an increase in ROI from 12% to 13% on earnings in the example provided?
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What does the retention ratio measure in terms of reinvestment?
What does the retention ratio measure in terms of reinvestment?
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When calculating the equity reinvestment rate, what is included in the formula?
When calculating the equity reinvestment rate, what is included in the formula?
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What factor is used to derive the Return on Capital or ROIC?
What factor is used to derive the Return on Capital or ROIC?
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What does a reinvestment rate lower than the growth rate in earnings indicate?
What does a reinvestment rate lower than the growth rate in earnings indicate?
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If a company reports a net income of $240 and retains 70% for reinvestment, what is the retention ratio?
If a company reports a net income of $240 and retains 70% for reinvestment, what is the retention ratio?
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Study Notes
Estimating Growth
- Growth can be good, bad, or neutral
- Growth is a double-edged sword
- The good side of growth is it increases revenues and operating income, potentially at varying rates.
- The bad side of growth is the need for reinvestment, requiring the setting aside of money.
- The net effect of growth is whether the good outweighs the bad.
Ways of Estimating Growth in Earnings
- Look at the past: Historical growth in earnings per share is a good starting point.
- Look at what others are estimating: Analyst estimates for many firms are helpful.
- Look at fundamentals: Operating income growth can be tied to reinvestment and returns for stable margins. A changing margins requires starting with revenue growth and then estimating reinvestment.
Historical Growth
- Historical growth rates can be estimated in various ways, including:
- Arithmetic versus Geometric Averages
- Simple versus Regression Models
- Historical growth rates can be sensitive to the period used (start and end points) and the metric used for estimation.
- Using historical growth rates requires accounting for negative earnings and scaling effects.
Motorola: Arithmetic vs. Geometric Growth Rates
- Data provided for Motorola's Revenues, EBITDA, and EBIT from 1994-1999.
- Demonstrates calculation of arithmetic and geometric averages.
- Displays standard deviations for each category.
A Test
- Time Warner's 1996 and 1997 earnings per share are given as example data.
- Students are asked to calculate growth rate in earnings per share based on this data.
Dealing with Negative Earnings
- When earnings in the starting period are negative, growth rate cannot be estimated directly.
- Three approaches to solve this problem are available:
- Use the higher of the two numbers (positive and negative values) as the denominator
- Use the absolute value of earnings in the starting period as the denominator
- Use a linear regression analysis and divide the coefficient with the average earnings.
The Effect of Size on Growth: Callaway Golf
- This section analyzes growth rates for Callaway Golf over time.
- Data on Net Profit and Growth Rate is provided for each year, and the Geometric Average Growth Rate is calculated.
Extrapolation and its Dangers
- This section illustrates how to estimate the future value given historical data on net profit.
- Net profit estimates are provided from 1996-2001 for an example.
Analyst Estimates
- Analysts spend significant time forecasting earnings per share for the next earnings report.
- Many analysts forecast earnings per share and expected growth over the next 5 years, but the analysis used is generally far more limited.
- Analyst forecasts of earnings per share and expected growth are widely disseminated.
How Good Are Analysts at Forecasting Growth?
- Analyst EPS forecasts are generally closer to actual EPS compared to simple time series models.
- The accuracy of analyst forecasts varies depending on the study, length of forecast period, and firm size.
Are Some Analysts More Equal Than Others?
- Studies of All-America Analysts show no strong evidence that they are better forecasters than other analysts initially.
- However, the chosen analysts tend to perform better following their selection.
- Earnings revisions by All-America analysts have a larger impact on stock prices.
The Five Deadly Sins of an Analyst
- Tunnel Vision: Focusing too much on a particular sector that one loses sight of other relevant information.
- Lemmingitis: Following trends or changing analyst recommendation without sufficient reason.
- Stockholm Syndrome: Identification with management that might hide important information.
- Factophobia: Basing recommendations on stories but refusing to consider facts.
- Dr. Jekyll/Mr.Hyde: Focusing solely on investment banking instead of unbiased valuation.
Propositions About Analyst Growth Rates
- Proposition 1: Analyst forecasts contain more public than private information.
- Proposition 2: The company is the primary source of private information for analysts.
- Proposition 3: Knowing analyst forecasts can be valuable though there are dangers like consensus opinions which can become misleading.
Sustainable Growth and Fundamentals
- This section describes the fundamental relation between growth rates and reinvestment rate.
Growth Rate Derivations
- In the special case of unchanging rates of return on investment, the growth rate formulas are simplified.
- If the rate of return on investment changes from period to period, the growth rates and other related measurements need to be adjusted to consider that changing data.
Estimating Fundamental Growth from New Investments
- Various calculations and measurements are used from earnings per share, net income, to operating income.
Expected Long Term Growth in EPS
- Retention ratio ( retained earnings/current earnings)
- Return on Investment (ROE = Net Income/Book Value of Equity)
- Formulas for expected growth rate calculations that considers unchanging ROE and Retention Ratio.
One Way to Pump Up ROE: Use More Debt
- Return on equity can be increased by employing more debt, as long as the interest expense on debt is lower than the rate of return on investment.
Expected Growth in Net Income from Non-Cash Assets
- Formulas for calculating expected growth in net income given non-cash assets.
- The formulas are more generalized to account for changing rates of return.
Estimating Expected Growth in Net Income from Non-Cash Assets: Coca-Cola in 2010
- Data on Coca-Cola in 2010 is used to demonstrate calculations of the growth rate in net income.
Expected Growth in EBIT and Fundamentals: Stable ROC and Reinvestment Rate
- The definitions for determining a reinvestment rate and return on investment (return on capital) are explained.
- The use of these formulas, and the implied relationship between capital expenditures, net growth, profitability for a company, are defined.
Estimating Growth in Operating Income, if Fundamentals Stay Locked In
- Example data from Cisco is used to show how estimated growth rate, given the reinvestment rate and the return on capital, can be misleading.
The Magical Number: ROIC (Or Any Accounting Return) and its Limits
- This section explains the accounting issues related to earnings and capital, while also considering how life-cycle effects to a company will affect short term and long-term ROIC numbers.
- This includes items like changes in accounting methods, unusual expenses, and the impact of inflation on reported capital values.
Operating Income Growth When Return on Capital Is Changing
- Formulas are presented here using marginal return on capital instead of a steady return on capital
- This is used when the return on capital and or growth rate is predicted to change
The Value of Growth
- Example data of various companies are provided to understand the concept of expected growth in different scenarios.
- Reinvestment rate, return on new investments, and existing invested capital are explained.
- Companies are ranked in descending order according to expected growth rate.
Top Down Growth
- Overview of top-down growth estimation as a method
Estimating Growth When Operating Income Is Negative or Margins Are Changing
- A three-step process to estimate growth in negative or changing operating income scenarios:
- Estimate growth rates in revenues
- Determine the market share
- Decrease growth rate as the firm expands
- Maintain the track of absolute revenue growth
Revenue Growth
- Market size and growth: determining market size and analyzing any changes
- Market share: determining current market share compared to competitors and opportunities related to market share growth.
Airbnb: Total Market
- Market size for the Airbnb services
- Airbnb market potential and growth rate potential explained.
Airbnb: Market Share
- Factors determining Airbnb market share and growth
- Analysis of Airbnb's competitors and their effects on profitability and growth
Target Margins (and Pathway There)
- How company's margins can be measured using unit economics, economies of scale, and competition which will guide target operating margins for different companies.
- Companies with low initial operating margins would have steeper pathways to achieving profits.
- Companies prioritizing growth over profit may take a longer time to reach target operating margins
Airbnb in November 2020: Growth and Profitability
- This section explains data on Airbnb's gross bookings, revenues, revenue growth, and operating margins.
Sales to Invested Capital
- How the ratio between sales and invested capital can help determine reinvestment rates and growth rates
- Factors to consider such as scaling effects and lags between investment.
Airbnb: Reinvestment and Profitability
- This sections explains how to compute reinvestment rates for companies like Airbnb.
Aggregate Versus Marginal Values
- Shows how marginal returns are different than overall company totals, and the importance of marginal analysis for companies that are investing.
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Description
This quiz covers the fundamentals of estimating growth in earnings, including the benefits and drawbacks of growth. It discusses historical growth rates and various methods to analyze them, such as averages and regression models. Test your knowledge on how to evaluate growth effectively.
