Valuation and Long-Term Growth Expectations
61 Pages Posted: 3 Dec 2019 Last revised: 6 Jan 2021
Date Written: November 18, 2019
A standard DCF corporate valuation usually includes a terminal value based on a long-term growth rate to reflect value from beyond the typical forecasting horizon of three to seven years. Despite often having a dominant effect on overall firm value, both the academic literature and practitioner conventions provide very little guidance on how this long-term growth rate should be determined. This paper addresses this gap: we undertake an exploratory analysis of how firms’ long-term growth is related to various firm and industry characteristics. We apply an extensive selection of potential predictors based on firm, industry, and market characteristics, in order to explain the variation in firms’ long-term growth rates. As such, we provide a predicted long-term growth rate for all firms, which can then be used as an input into a DCF valuation. We find that market prices do not seem to capture the full information that we find in long-term growth predictions. Thus, a trading strategy that goes long the decile with the highest long-term growth expectations and short the bottom decile yields positive and statistically significant abnormal returns in the range from ten to thirteen percent per year.
Keywords: Valuation, Terminal Value, Long-Term Growth Rates, Market Efficiency
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