Contents
- Index
Concept 2: Abnormal Earnings Growth Estimation
©2009 OS Financial Trading System
In the previous section we computed the Comprehensive Earnings per share for 2008 as $4.37758. To estimate Abnormal Earnings Growth we need to estimate 2009 Cum-dividend earnings.
2008 Earningst = Earningst + Cost of Equity Capital*Dividendt-1
Dividends 2008
To assess abnormal earnings growth over time we further need to assess the future growth behavior of earnings as well as adjustments required Cum-dividend earnings. The dividend information is available from the following.
Source 2008 10-K IBM SEC Filing
Continuing the example using the 10-K filings then the dividend per share for IBM equals:
Dividend per Share = Dividends/(Shares issued - Treasury Stock) = 2,585/(2,096.981860 - 757.885937) = $1.9305 equals the dividend per share.
Comprehensive income = $12,334 + ($6472) = $5862
Comprehensive Earnings per share = $5,862/(2,096.981860 - 757.885937) = $4.37758
Dividend Payout Ratio (Relative to Comprehensive Income) = 2585/5,862 = 0.440976
Earnings Growth
What is the consensus abnormal growth forecast for IBM?
Here we will check two general sources from the web Yahoo Finance and MSN Money. These numbers are constantly revised over time in response to changes in the economy. For example, around April 2009 these numbers were:
Yahoo Finance
MSN Investor
From the above the reported consensus forecasts for earnings are:
Current Year (FY2009): 1.7% and 1.8%
FY 2010: 8.4% and 9.1%
5-year projection: 9.83% and 9.60%
MSN usually adjusts more frequently their reported growth numbers so we will place a little more weight on the MSN numbers. We will use 1.775%, 8.9% and 9.65% respectively as a first pass.
In a two stage abnormal growth model growth behavior is accurately forecast out for some period of time which is usually 5-years. Then a simplifying assumption is 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.
First, refer to the following Government report. Long Term Growth in the US: In a 2005 Report to Congress on Long Term Growth for the US economy. The following quote was given:
<http://www.ftsmodules.com/public/modules/ftsRT/projects/longtermgrowth.pdf>
"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% 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%.
Projecting Earnings
Dividend per Share = Dividends/(Shares issued - Treasury Stock) = 2,585/(2,096.981860 - 757.885937) = $1.9305 equals the dividend per share.
Comprehensive Earnings Per Share = Net Income / (Shares issued - Treasury Stock) = 5,862/(2,096.981860 - 757.885937) = $4.37758
Comprehensive EPS FY 2009 $4.377*1.0175 = $4.454, Growth 0.0175
Comprehensive EPS FY 2010 $9.37*1.089 = $4.85, Growth 0.089
5-Year Growth = 0.0965
Normal Growth = 0.045
Projected Dividend Per Share (Next Year) = $9.37*0.2095 = $1.96
Years in Abnormal Growth Stage 1: 5-years
To complete the earnings calculations we need first to estimate the cost of equity capital. We turn our attention to this in the next section.