Improving the Discounted Earnings Growth Model for Calculating Intrinsic Value

Determining a company's stock's intrinsic value is a crucial step in the decision-making process for investors and financial analysts. The Discounted Earnings Growth Model, often called Discounted Future Earnings, is one method for calculating this intrinsic value. The profits worth of a company and its expected terminal value at a later time can be predicted in an organized manner with the help of this model. In this context, terminal value refers to all of the anticipated future cash flows that will reflect predicted returns after the initial projection period, which might be difficult to forecast.

The fundamental idea behind this model is to take future earnings of a company, apply a suitable discount rate to bring those earnings down to their present value, and then add the present value of the predicted terminal value to the sum of these discounted future earnings. The intrinsic worth of the company is provided by the computation's outcome.

Sum of Future Discounted Earnings = Earnings Year 1 / (1 + Discount Rate)^1 + Earnings Year 2 / (1 + Discount Rate)^2 + ... + Earnings Year n / (1 + Discount Rate)^n

Let's examine the key elements of this model in more detail:

1. EPS
   A crucial financial indicator for determining a company's profitability is earnings per share (EPS). The total earnings available to common shareholders are divided by the total number of outstanding common shares to determine the earnings per share (EPS). In essence, it indicates how much money each share would get at the end of the year if all earnings were divided among the outstanding shares.
2. EPS Growth Rate (%)
   The predicted rate of growth for a company's earnings in the future is represented by the EPS Growth Rate. Investors might refer to the average EPS growth rate for the industry or the firm over a given time period, usually three to ten years, as a point of reference.
3. Years of Growth
   Years of Growth is a term used to describe the duration of time during which earnings growth is anticipated for a corporation. During the Annual General Meeting, the CEO of the company frequently makes this projection public, or it can be deduced from trends in industry growth.
4. Discount Rate(%)
   To reduce future earnings or cash flows to their present value, the discount rate—also known as the necessary rate of return for investors—is used. A number of techniques, such as the Capital Asset Pricing Model (CAPM), can be used to calculate it. A 10% discount rate is considered moderate, whereas a 20% discount rate is considered aggressive.
5. Terminal Growth Rate (%)
   A company's growth after the initial projection period is estimated using the terminal growth rate, which captures the company's future income expansion. Remember that the terminal growth rate ought to be less than the discount rate at all times.
   It is important to note that although the Discounted Earnings Growth Model is a useful tool for determining intrinsic value, the final valuation is heavily dependent on the correctness of a number of assumptions.

Comprehending the Discounted Earnings Growth Model is an essential competency for financial analysts and investors. It enables you to calculate the intrinsic value of a stock by evaluating critical financial measures, growth estimates, future earnings, and terminal value.