Course 309: Steady-State Value
The Value of Growth
In this course
1 Introduction
2 Determining Steady-State Value
3 The Value of Growth

To go the final step and determine how much today's stock price reflects expectations of future growth, you need to know the market value of the company, which is also known as market capitalization or "market cap." To calculate market value, take the total number of outstanding shares and multiply it by the current stock price. Market value = total number of outstanding shares x stock price Morningstar calculates market cap, which changes every time a stock's price changes, in each stock's Quicktake Report. Ford's market value in late December 1999 was $60 billion. You can determine the value of growth by subtracting the steady-state value from market value. In Ford's case, the steady-state value of $140 billion exceeds the market value of $60 billion, giving you a value of growth of negative $80 billion. Since Ford's steady-state value is greater than the market value, Ford would not have to grow at all to justify its current share price. Does that make this stock a bargain? Not necessarily. When a company's steady-state value exceeds its market cap, it just means the market expects free cash flows to decline. Given the cyclical nature of the auto industry, the market's pessimistic view of Ford is probably right on target. Contrast Ford with AMZN, the online bookseller. Amazon's free cash flow is minimal right now because it's too busy investing every available dollar in the business. Going through the same calculation we did with Ford, we get a steady-state value for Amazon of $30 million. That's tiny compared with Amazon's market value of $32 billion at the end of 1999. Since Amazon's steady-state value is negligible compared to its market value, growth represents 100% of the stock's price. That means even if Amazon maintains its current level of profitability, it's still literally worthless. All its worth and then some hinges on future growth. Most companies lie between these two extremes. For large-cap companies that generate positive free cash flow, for example, the average mix was about 38% steady-state profits and 62% growth for 1999. (That figure has historically been closer to 50/50.) A company like Coca-Cola KO will land on the growth side of the average. If Coca-Cola generates $2.5 billion in free cash flow each year from now on, its business is worth $25 billion, or 17% of its stock price. The other 83% is growth. Rocket science it isn't, but this method does provide a quick way to gauge the growth assumptions built into a stock price. If you stumble onto a company whose future growth represents all, or nearly all, of its market value, then before buying the stock you'd better be darned sure the company's really going to grow rapidly for a long time. Otherwise you won't get enough future profits to justify the price tag.

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