7.19 Forecasting Growth
In the previous chapter on Dividend
Models we introduced the concept of Normal Growth.
This number is bound by the economy wide growth and thus 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.
The following justification for the upper bound on Normal
Growth was presented in the Dividend Model chapter but we will
summarize the arguments here for completeness.
First, in a 2005
Report to Congress on Long Term Growth for the US economy.
The following quote was given:
“We also observe over the last
100-year span that the rates of economic growth across the then
emerging industrial nations were fairly tightly clustered around
this 2.0% pace. At the high end was Japan with an annual rate of
growth averaging about 2.7%, while at the low end was Great
Britain with an annual growth rate averaging 1.4%. The United
States, which grew at a 1.8% average annual rate, was slightly
below average.”
They also went
on to observe:
“For the United States, the long-term growth of real GDP per capita over
the last 125 years has revealed remarkable steadiness, advancing
decade after decade with only modest and temporary variation
from the observed 1.8% annual rate of increase.”
Inflation has
been a fact of life for the U.S. economy.
Inflation numbers suggest that inflation compounded from 1913
to 2008 resulted in a cumulative rate of 2071.23%[1]
This, implies an annual constant compounded rate of
approximately 3.24%.
Combining the
above we can make a reasonable estimate for one plus the long term
nominal growth in the US, to be around 1.018*1.03 = 1.04854.
As a result, to be conservative we will use as an upper bound
for economy wide growth for US stocks (i.e., the stage 2 growth
rate) the rounded down number of 4.5%.
We
now have three important inputs into the problem of assessing the
intrinsic value for IBM.
1.
FCFE per share ($10.39)
2.
Stage 1 growth (0.10)
3.
Stage 2 growth (0.045)
We next turn
our attention to the discount rate – that is assessing IBM’s Cost of
Equity Capital.
[1]
Source www.InflationData.com