Long-term Growth Rates in Earnings
May 2025
When using the guideline company method to value a business it is not unusual to find reasonably comparable guideline companies that have very different expected long-term growth rates in earnings from the subject company’s. One way to address this problem is to use growth-adjusted market multiples. The mathematical adjustment is easy. You convert the market multiple of the guideline company to a capitalization rate, adjust the capitalization rate for the difference in growth rates between the guideline company and the subject company. For example, assume the long-term expected growth rate in earnings for the subject company is 5%, the long-term expected growth in earnings for the guideline company is 10% and the market multiple of the guideline company is 20. First, the market multiple of 20 is converted to a capitalization rate of 5% by dividing 1 by 20, or 1/20. Next, the long-term expected growth rate of the guideline company of 10% is added to the 5% capitalization rate to derive a no-growth capitalization rate of 15%. Lastly, the expected long-term growth rate in earnings of the subject company of 5% is subtracted from the no-growth capitalization rate of 15% to derive a growth-adjusted capitalization rate of 10% and a growth adjusted market multiple of 10.
While the calculation of the growth-adjusted market multiple is straight-forward, determining the inputs of the expected long-term growth rates in earnings of the subject company and the guideline company is more subjective. The expected long-term growth rate in earnings of the subject company can be estimated by interviewing management and considering historical growth in earnings and any projections of earnings available. The expected long-term growth rate in earnings of the guideline company, if publicly-traded, can be estimated by considering historical growth in earnings and any projections of earnings available, such as projections often published by market analysts.
To summarize, growth-adjusted market multiples are relatively easy to calculate, but inputs are more subjective. In any event, growth-adjusted market multiples will likely produce more accurate business valuations than non-adjusted market multiples.
Relevant Court Cases
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Callum Herdson v. Richard Fortin, et al.,
Court of Appeals of Washington,
No. 86536-6-I,
filed May 5, 2025
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Hunnewell Partners (BVI) Ltd. v. Deloitte
Transactions & Business Analytics LLP,
Appellate Division of the Supreme Court of New York,
2025 NY Slip Op 03014,
decided May 20, 2025
Recent Business Valuation Articles
-
“Futureproofing Companies &
Valuation Ratios,”
by Wander Marijnissen, Dirk Schoenmaker and
Willem Schramade,
dated May 5, 2025
-
“When Harry Leaves Sally: Digital
Assets in Divorce and Succession,”
by Brian Sanya Mondoh, Sara Adami-Johnson and
Palesa Roza Gwele,
dated April 12, 2025
Recent Engagements
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partnership interests in a mostly
real estate holding partnership on a
controlling and minority interest
basis for estate tax reporting purposes.
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a specialty contracting firm on
a minority interest basis
for issuance/income tax
reporting purposes.
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common stock of a specialty
distributor on a controlling
interest basis for phantom stock
purposes.
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member interests of a niche
fuel service provider on a
controlling interest basis
for purchase/sale
purposes.
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