9.4  Concept 2  Estimating Abnormal Earnings Growth

In the previous section we computed the Comprehensive Earnings per share for 2009 as $7.543.  To estimate Abnormal Earnings Growth we need to estimate 2010 Cum-dividend earnings.

2009 Earnings_t = Earnings_t + Cost of Equity Capital*Dividend_t-1

Operational Details

Dividend Information is available from the Consolidated Statement of Changes in Equity (see chapter 1) which was exported into Excel from the SEC in chapter 1:

Again from the Income Statement the average number of shares outstanding respectively for:  2009, 2008 and 2007

Continuing the example using the 10-K filings then the dividend per share for IBM equals:

Dividend per Share = Dividends/Shares outstanding = 2,860/1341 = $2.132 equals the dividend per share.

Dividend Payout Ratio (Relative to Comprehensive Earnings) = 2860/10115 = 0.283

Comprehensive Earnings per share = $10,115/1341 = $7.543

Growth Forecasts

What is the consensus 5-year growth forecast for IBM?

In Valuation Tutor click on Analysts, see above, to check current consensus forecasts. Analysts revise their estimates over time in response to changes in the economy.  At the time of this example these were:

We will use the average of these estimates: FY2010:  12.55%, FY2011:  9.4% and for 5-Years:  10.43% respectively as a first pass.

In a two stage growth model forecasts growth behavior for some period of time, often 5-7 years.  A simplifying assumption is then made that the income grows in perpetuity at some constant rate.  This constant rate is referred to as the normal growth rate.  The normal growth rate is constrained by economy wide growth as we cannot assume that a stock grows in perpetuity at a greater rate than this constraint.  Otherwise, the stock (in the distant future) is implied to grow larger than the economy as a whole – a contradiction.

Normal Growth Example:  We will use 4.5% for the stage 2 normal growth estimate as a conservative long term average growth rate for IBM.  This number can be justified from long term macroeconomic data for the US economy  (See chapter 4 or chapter 5) or click on Papers & Reports in Valuation Tutor as depicted above:

The one plus the long term nominal growth in the US is around 1.018*1.03 = 1.04854. 

As a result, to be conservative we will round down and use as an upper bound for economy wide growth for US stocks to be 4.5%.