Chapter_12 - Chapter 12 Chapter The Analysis of Growth and...

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Chapter 12 Chapter 12 The Analysis of Growth and Sustainable Earnings
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The Analysis of Growth and The Analysis of Growth and Sustainable Earnings Sustainable Earnings Chapter 11 laid out the analysis of profitability Link to Previous Chapter LINKS This chapter analyzes growth This Chapter Part III of the book applies the analysis of profitability and growth to forecasting and valuation Link to Next Chapter Link to Web Page How are sustainable earnings identified ? How is growth in investment analyzed ? How is the analysis of growth incorporated in the evaluation of the P/E and P/B ratios? What is “growth” in a valuation context? What is a growth company? Explore the web page
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What you will learn from this What you will learn from this Chapter Chapter Why the analysis of growth is important for valuation Why growth analysis focuses on residual earnings growth and abnormal earnings growth rather than earnings growth What a growth firm is What sustainable earnings are and how to identify them What transitory earnings are What “quality of earnings” means How firms can generate unsustainable earnings How operating leverage affects earnings as sales change How changes in ROCE can be created by borrowing What drives growth in the common shareholders’ equity
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What Is Growth and How Is What Is Growth and How Is It Valued? It Valued? Growth in sales? Growth is assets? Growth in equity? Growth in earnings? Does a high P/E ratio indicate a growth company? Does a high P/B ratio indicate a growth company?
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Remember the Caveat Remember the Caveat (Chapters 5 and 6) (Chapters 5 and 6) Firms can grow earnings, but not create value Earnings growth generated by investment Earnings growth generated by the accounting Value-added growth: Think of growth in residual earnings and abnormal earnings growth A reminder: abnormal earnings growth (AEG) is equal to growth in residual earnings (ΔRE)
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A Growth Company: General Electric, Corp. General Electric, Corp. (Dollar amounts in millions) 2002 2001 2000 1999 1998 1997 Sales 131,698 125,913 129,853 111,630 100,469 90,840 Sales growth rate 4.6% (3.0%) 16.3% 11.1% 10.6% 14.7% Common equity 68,706 54,824 50,492 42,557 38,880 34,438 Common equity growth rate 16.2% 8.6% 18.6% 5.5% 12.97% 10.6% ROCE 25.8% 27.1% 29.9% 27.6% 26.2% 27.2% Residual earnings 7,539 7,625 7,628 6,065 5,221 4,994 Abnormal earnings growth (86) (3) 1,563 844 227 General Electric has maintained a high growth rate in sales, which translates into both increasing ROCE and increasing investment. Accordingly, with the exception of 1996, residual earnings (based on a required return of 12%) was on a growth path up to 2000 and abnormal earnings growth was (mainly) positive. Growth slowed after 2000. Can GE generate more growth in the future? A reminder: Abnormal earnings growth = ΔRE
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Chapter_12 - Chapter 12 Chapter The Analysis of Growth and...

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