Contents - Index

Concept 2:  Growth Forecasts
©2009 OS Financial Trading System


A common way of projecting out future FCFE per share is to assess the future growth behavior for the firm.  We adopt this approach next in two stages for a going concern.  First, we will assume that FCFE can grow at some abnormal rate over the short run and then at some normal rate thereafter.  The latter normal rate is constrained by economy wide constraints to avoid the undesirable implication that a firm can grow at a larger rate than the economy as a whole.
Given the importance of this number financial analysts provide ongoing estimates for growth which today are freely available over the web.
Abnormal Growth Example:  What is the consensus abnormal growth forecast for IBM? (around April 2008)
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


Thus the current consensus appears to be between 9.2% and 13.60% for 5-years abnormal growth.  MSN usually adjusts more frequently their reported growth numbers and so more weight can be placed on the MSN reported consensus.  
Note:  The consensus analyst forecast is known in the academic literature to have some biases associated with it and therefore in this current exercise we will apply a relative conservative estimate of (9.2%+13.60%)/2 = 11.4% for abnormal growth.  If this proves to be problematic then we will return in the sensitivity analysis.
Stage 1 Growth = Abnormal Growth = 11.4%
Important Remark:
The abnormal growth consensus is for Accounting Earnings.  As a first pass we will apply this to FCFE growth, however, two immediate observations here are that per share FCFE for IBM is greater than EPS and second, management can manage EPS growth more easily than FCFE growth.  As a result, the growth forecast for EPS may be different for IBM than the growth forecast for FCFE.  Issues of this nature must be assessed at an individual company level.  We will return to these issues later when we do some sensitivity analysis.
Normal Growth Example:  This number we will assume is bound by the economy wide growth.  As a result, 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%.  
Summary:
We now have three important inputs into the problem of assessing the intrinsic value for IBM.
1.  FCFE per share ($9.049) - adjusted for pension costs expected to re-occur.
2. Abnormal growth (11.4%) - stage 1 growth in a two stage abnormal growth model.
3. Normal growth (4.5%)
We next turn our attention to the discount rate - that is assessing IBM's Cost of Equity Capital.