Long-run Growth Rates in Discounted Cash Flow Models

Abstract

Long-run growth rates play a central role in all discounted cash flow models. This is true whether the goal is to estimate the value of a company or to estimate the cost of equity. It is well recognized as a matter of mathematics—although not always incorporated into practice—that the long-run expected growth rate cannot exceed the growth rate of the aggregate economy. What is less widely appreciated is that as an empirical matter the long-run growth rates for existing companies (that is, companies that are being appraised or whose cost of equity is being estimated) are almost certain to be less than the growth rate of the aggregate economy. Based on analysis of net dilution from 1926 to 2017, a more reasonable approximation for the average long-run growth of existing companies is approximately two percentage points less than the expected nominal growth rate of GDP.