How To Value A Stock Using The Sustainable Earnings Growth Model
Today, I’ll share another valuation tool that you can use in order to foresee a stock’s future growth earnings potential.
Sustainable Earnings Growth Valuation Model
The principle of this model is very simple; it’s almost the same as the Historical Earnings Growth model. This principle uses a company’s sustainable growth rate ratio, a measure of how much a firm can grow without using leverage, to predict its stock price.
I’m sure you’re confused. But that’s okay, it’s not as confusing as you think it is.
To understand it better, let’s see how its done. Let’s look back again at the historical data and the 7-yr. averages of my first stock, MEG.
The Sustainable Growth Rate if MEG is 10.6%. It’s computed using the formula below;[alert-note]% Sustainable Growth = ROE * (1-Payout Ratio)[/alert-note]
What these means is that MEG’s book value per share (BVPS) is assumed to grow in this rate. To make it easy to understand, let’s make a spreadsheet file similar below;
We make use of the current BVPS to compute for the current EPS and DPS using average ROE and Payout Ratio. So, let’s compute! To compute for the EPS, we multiply BVPS to ROE. For the DPS, we multiply EPS to Payout Ratio.[alert-note]EPS = 3.44 * 0.114 = 0.39[/alert-note] [alert-note]DPS = 0.39 * 0.07 = 0.03[/alert-note]
Now, to compute for the BVPS for year 1, we simply add BVPS and the EPS and subtract the DPS for the previous year.[alert-note]BVPS (year 1) = 3.44 + 0.39 – 0.03 = 3.81[/alert-note]
Take note that by using the Sustainable Growth Rate, we can also derive the same BVPS as shown below.[alert-note]BVPS = 3.44 * (1+0.106) = 3.81[/alert-note]
Now let’s continue the whole process by repeating it until you reach the tenth year to arrive an estimated BVPS, EPS and DPS of 9.46, 1.08 and 0.08 respectively. Confused? Don’t be! We’re nearing the end! Just bear with me.
Now, to get the projected price, we multiply the EPS after 10 years to the average P/E ratio.
To get the sum of all dividends paid after 10 years, we just add it all up and after that, we add it to the projected price to get our total predicted gain.[alert-note]Projected price = 1.08 * 8.3 = 8.95[/alert-note] [alert-note]Sum of all dividends paid = 0.53[/alert-note] [alert-note]Total gain = 8.95 + 0.53 = 9.48[/alert-note]
With that total gain of 9.48 Php per share, I hope that it will soon become a reality as reported in this news way back in 2013. I hope you enjoy valuating your favorite businesses and help you decide on how will you invest for your future.