8.12  Application IBM Step 3:  Estimating Growth in Book Values

To project residual earnings over time we further need to assess the growth behavior of the book value per share.  This requires combining information about earnings growth rates as well as dividend policy as described next.

When we enter period t, the book value is BV_t-1.  In period t, comprehensive income CI_t is generated, and if the firm pays dividends, d_t is paid out in dividends.  If no new shares are issued, then the book value at the end of period t is

BV_t  = CI_t +  BV_t-1  - d_t

IBM Example:  

Projecting residual income over time requires that we account for the evolution of dividends and changes in book value over time.  This requires assessing dividend policy relative to Comprehensive Income as opposed to regular accounting income.

Dividend Information is available from the Consolidated Statement of Changes in Equity (see chapter 1) which was exported into Excel from the SEC in chapter 1:

 Again from the Income Statement the average number of shares outstanding respectively for:  2009, 2008 and 2007

Continuing the example using the 10-K filings then the dividend per share for IBM equals:

Dividend forecast information from analysts is available on the web.  For example, in Valuation Tutor click on Profile to access analyst forecasts for dividends for IBM:

The forward annual dividend is predicted to be $2.60 per share.

Dividend Summary

Growth Forecasts

What is the consensus 5-year growth forecast for IBM?

Here as a first pass you can check consensus analyst forecasts from a couple of sources on the Web.  To check consensus forecasts click on Analysts in Valuation Tutor. 

These numbers are constantly revised over time in response to changes in the economy.  At the time of this example these were:

We will use the average of these estimates: FY2010:  12.55%, FY2011:  9.4% and for 5-Years:  10.43% respectively as a first pass.

In a two stage growth model growth behavior is accurately forecast out for some period of time which is usually 5-years.  Then a simplifying assumption is made that the income grows in perpetuity at some constant rate.  This constant rate is referred to as the normal growth rate.  The normal growth rate is constrained by economy wide growth as we cannot assume that a stock grows in perpetuity at a greater rate than this constraint.  Otherwise, the stock (in the distant future) is implied to grow larger than the economy as a whole – a contradiction.