When you buy a stock, you become part owner in a business. What you're really getting is a stream of future profits. So how do you know if you're paying a fair price now for future profits?
One way to find out is to isolate what the company would be worth if profits were to continue just as they are now. Once you've determined that "steady-state" value, then you know that all other expected profits would have to come from growth, and thus what you're paying for that growth.
The company's steady-state value represents the company just as it is now, generating the same level of cash year after year. The second element--the growth component--is what's left over. The growth is the difference between the market value of the company and its steady-state value.
Value of growth = market value steady-state value
Determining Steady-State Value >>