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7.19  Forecasting Growth:  Stage 2 (Normal Growth)

In the previous chapter on Dividend Models we introduced the concept of Normal Growth.  This number is bound by the economy wide growth and thus we will use 4.5% for the stage 2 normal growth estimate as a conservative long term average growth rate for IBM.  This number can be justified from long term macroeconomic data for the US economy.   The following justification for the upper bound on Normal Growth was presented in the Dividend Model chapter but we will summarize the arguments here for completeness.

First, in a 2005 Report to Congress on Long Term Growth for the US economy.   The following quote was given:

 “We also observe over the last 100-year span that the rates of economic growth across the then emerging industrial nations were fairly tightly clustered around this 2.0% pace. At the high end was Japan with an annual rate of growth averaging about 2.7%, while at the low end was Great Britain with an annual growth rate averaging 1.4%. The United States, which grew at a 1.8% average annual rate, was slightly below average.”

They also went on to observe:

“For the United States, the long-term growth of real GDP per capita over the last 125 years has revealed remarkable steadiness, advancing decade after decade with only modest and temporary variation from the observed 1.8% annual rate of increase.”

Inflation has been a fact of life for the U.S. economy.   Inflation numbers suggest that inflation compounded from 1913 to 2008 resulted in a cumulative rate of 2071.23%[1]  This, implies an annual constant compounded rate of approximately 3.24%.

Combining the above we can make a reasonable estimate for one plus the long term nominal growth in the US, to be around 1.018*1.03 = 1.04854.  As a result, to be conservative we will use as an upper bound for economy wide growth for US stocks (i.e., the stage 2 growth rate) the rounded down number of 4.5%. 

Summary

We now have three important inputs into the problem of assessing the intrinsic value for IBM.

1.      FCFE per share ($10.39)

2.      Stage 1 growth (0.10)

3.      Stage 2 growth (0.045)

We next turn our attention to the discount rate – that is assessing IBM’s Cost of Equity Capital.

[1] Source www.InflationData.com