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A comparison of alternative models for estimating firm’s growth rate

Author

Listed:
  • Ivan E. Brick

    (Rutgers University)

  • Hong-Yi Chen

    (National Chengchi University)

  • Chia-Hsun Hsieh

    (National Central University)

  • Cheng-Few Lee

    (Rutgers University)

Abstract

The growth rate plays an important role in determining a firm’s asset and equity values, nevertheless the basic assumptions of the growth rate estimation model are less well understood. In this paper, we demonstrate that the model makes strong assumptions regarding the financing mix of the firm. In addition, we discuss various methods to estimate firms’ growth rate, including arithmetic average method, geometric average method, compound-sum method, continuous regression method, discrete regression method, and inferred method. We demonstrate that the arithmetic average method is very sensitive to extreme observations, and the regression methods yield similar but somewhat smaller estimates of the growth rate compared to the compound-sum method. Interestingly, the ex-post forecast shows that arithmetic average method (compound-sum method) yields the best (worst) performance with respect to estimating firm’s future dividend growth rate. Firm characteristics, like size, book-to-market ratio, and systematic risk, have significant influence on the forecast errors of dividend and sales growth rate estimation.

Suggested Citation

  • Ivan E. Brick & Hong-Yi Chen & Chia-Hsun Hsieh & Cheng-Few Lee, 2016. "A comparison of alternative models for estimating firm’s growth rate," Review of Quantitative Finance and Accounting, Springer, vol. 47(2), pages 369-393, August.
    • Handle: RePEc:kap:rqfnac:v:47:y:2016:i:2:d:10.1007_s11156-015-0504-6
    DOI: 10.1007/s11156-015-0504-6
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    References listed on IDEAS

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    1. Fama, Eugene F & French, Kenneth R, 1992. "The Cross-Section of Expected Stock Returns," Journal of Finance, American Finance Association, vol. 47(2), pages 427-465, June.
    2. Myron J. Gordon & Eli Shapiro, 1956. "Capital Equipment Analysis: The Required Rate of Profit," Management Science, INFORMS, vol. 3(1), pages 102-110, October.
    3. Cheng-Few Lee & Joseph Finnerty & John Lee & Alice C Lee & Donald Wort, 2012. "Security Analysis, Portfolio Management, and Financial Derivatives," World Scientific Books, World Scientific Publishing Co. Pte. Ltd., number 8116, February.
    4. Hong-Yi Chen & Manak C. Gupta & Alice C. Lee & Cheng Few Lee, 2020. "Sustainable Growth Rate, Optimal Growth Rate, and Optimal Payout Ratio: A Joint Optimization Approach," World Scientific Book Chapters, in: Cheng Few Lee & John C Lee (ed.), HANDBOOK OF FINANCIAL ECONOMETRICS, MATHEMATICS, STATISTICS, AND MACHINE LEARNING, chapter 97, pages 3413-3464, World Scientific Publishing Co. Pte. Ltd..
    5. Cheng Few Lee & Manak C. Gupta & Hong-Yi Chen & Alice C. Lee, 2020. "Optimal Payout Ratio Under Uncertainty and the Flexibility Hypothesis: Theory and Empirical Evidence," World Scientific Book Chapters, in: Cheng Few Lee & John C Lee (ed.), HANDBOOK OF FINANCIAL ECONOMETRICS, MATHEMATICS, STATISTICS, AND MACHINE LEARNING, chapter 96, pages 3367-3412, World Scientific Publishing Co. Pte. Ltd..
    6. Brick, Ivan E & Weaver, Daniel G, 1997. "Calculating the Cost of Capital of an Unlevered Firm for Use in Project Evaluation," Review of Quantitative Finance and Accounting, Springer, vol. 9(2), pages 111-129, September.
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    Cited by:

    1. Murat Ocak & Derya Fındık, 2019. "The Impact of Intangible Assets and Sub-Components of Intangible Assets on Sustainable Growth and Firm Value: Evidence from Turkish Listed Firms," Sustainability, MDPI, vol. 11(19), pages 1-23, September.

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    More about this item

    Keywords

    Equity valuation; Estimation of growth rate; Gordon’s growth model; Determinants of growth forecast errors;
    All these keywords.

    JEL classification:

    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • G35 - Financial Economics - - Corporate Finance and Governance - - - Payout Policy

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