Take a fresh look at your long-term growth rate, says Grabowski

BVWireIssue #240-3
September 28, 2022

economic data for valuations
economic forecast, industry analysis, valuation report, COVID-19

Do you estimate a long-term growth rate by taking long-term real GDP growth plus expected inflation? If you do, you may want to reconsider, according to recent research by Roger Grabowski (Kroll) and Ashok Abbott (West Virginia University). Grabowski conducted an interesting session at the recent ASA 2022 International Conference in Tampa, Fla., and he says that common approach is wrong. Reason: GDP includes both existing firms and new firms, whose growth is driven by acquisition. GDP growth is being driven by firms such as Amazon and Apple—businesses that did not exist 20 years ago—so you can’t assume your subject company will grow at the rate of GDP, he says. Therefore, the expected long-term growth rate should reflect “organic” growth, so the effect of the acquisitions should be backed out. 

Grabowski cites research that estimates real long-term growth in aggregate corporate earnings at 3%, with 2% attributable to new companies. Therefore, the long-term average real earnings for existing businesses (i.e., organic growth) is equal to 1%, or one-third. This means your subject company will, on average, grow at the rate of one-third of real GDP plus inflation.

Please let us know if you have any comments about this article or enhancements you would like to see.