Earnings growth

In investments, earnings growth refers to the annual rate of growth of earnings. When the dividend payout rate is same, the dividend growth rate is equal to the earnings growth rate.

Earnings growth rate is a key value that is needed when the DCF model, or the Gordon's model is used for stock valuation.

The present value of a stock is given by

$P=D\cdot \sum _{i=1}^{\infty }\left({\frac {1+g_{i}}{1+k}}\right)^{i}$ .

where P = the present value, k = discount rate, D = current divident and $g_{i}$ is the revenue growth rate for period i.

If the growth rate is constant for $i=n$ to $\infty$, then,

$P=D\cdot {\frac {1+g_{1}}{1+k}}+D\cdot ({\frac {1+g_{2}}{1+k}})^{2}+...+D\cdot ({\frac {1+g_{n}}{1+k}})^{n}+D\cdot \sum _{i=n+1}^{\infty }\left({\frac {1+g_{\infty }}{1+k}}\right)^{i}$

The last term corresponts to the terminal case.

When the growth rate is always the same for perpetuity, the Gordon's model results:

$P=D\times {\frac {1+g}{k-g}}$.

As the Gordon's model suggests, the valuation is very sensitive to the value of g used.

==P/E and growth rate.

See also

• Discounted cash flow model