in Valuing Businesses
August 2025
Under the capitalization of earnings method of valuing a business, projected long-term growth in earnings is a vital input. This estimated growth rate is into perpetuity as required in the formula. The formula for calculation of a business value under the capitalization of earnings methodology is earnings divided by the sum of the discount rate less long-term growth (growth into perpetuity). A small difference in the projected long-term growth rate in earnings can produce a significant change in value. For example, a business with earnings of $1 million, a discount rate (rate of required return) of 25% and a projected growth rate in earnings into perpetuity of 5% produces a value of $5 million ($1 million / (25% - 5%) = $5 million). If the projected growth rate is lowered to 3% the value becomes $4.55 million ($1 million / (25% - 3%) = $4.55 million).
It should be noted that although it is theoretically possible for a business to have a growth rate into perpetuity that is higher than the projected growth rate into perpetuity of the overall economy, it is practically impossible because it would mean that the subject business would eventually pass the economy in size. Thus, the long-term growth into perpetuity of the economy sets a practical ceiling on the projected long-term growth of a business. Note that short-term growth of a business can, and often does, differ substantially from that of the economy. Therefore, it is important to estimate a long-term growth rate that is reasonable.
The typical methods of estimating this projected long-term growth is to: 1) utilize historical growth; 2) utilize projections; and 3) consider economic, industry and market growth. Although it’s easy to calculate historical growth, the problem is that future growth is rarely equal to historical growth. Therefore, historical growth shouldn’t blindly be used as the sole method for estimating projected growth. Projections can reasonably be used to estimate long-term growth, but projections usually are for five years or less so growth rates in the projection may not reflect reasonable growth after the projection period. It’s fairly easy to obtain projected long-term growth in the economy, industry or market but a business rarely grows at the same rate as the economy, industry or market. So these growth rates shouldn’t be blindly used as the sole method for estimating growth.
All in all, the best way to estimate long-term projected growth of earnings in a business is to utilize all three methods, weighting the results as needed, considering the quality and quantity of the data available in each method.
Relevant Court Cases
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Peggy Downing v. Shoreside Petroleum, Inc.,
The Supreme Court of Alaska,
No. S-18834,
dated January 17, 2025
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The State of Delaware v. PITB, LLC and Stafford
Street Capital, LLC,
Superior Court of Delaware,
C.A. No. S21C-07-016 MHC,
decided July 8, 2025
Recent Business Valuation Articles
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“Valuation and Long-Term
Growth Expectations,”
by Angel Tengulov, Josef Zechner and
Jeffrey Zwiebel,
Journal of Financial and Quantitative
Analysis,
dated April 7, 2025
-
“SIRRIPA - A Groundbreaking Return
Metric to Value Stocks Just Like Bonds,”
by Rainsy Sam,
dated July 21, 2025
Recent Engagements
- Valuation of a limited partnership
interest and a general partnership
interest in a mostly real estate
holding partnership on a minority
interest basis for estate tax
reporting purposes.
- Consulting regarding 100% of
the common stock of a niche contracting
company on a controlling interest basis
for corporate planning purposes.
- Valuation of the Class B
non-voting common stock
of a manufacturer of industrial
products on a minority interest
basis for gift tax
reporting/sale purposes.
- Consulting regarding 100% of
the member interests of a
specialty bar/restaurant
on a controlling interest basis
for possible purchase purposes.
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