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87 - Cost of Growth Valuation and Asset / Earnings Equivalence

The DIY Investing Podcast

Release Date: 08/09/2020

93 - OTC Markets Business Analysis with Ralph Molina of Midstory Ventures show art 93 - OTC Markets Business Analysis with Ralph Molina of Midstory Ventures

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92 - Discount Rates: Past, Present, and Future show art 92 - Discount Rates: Past, Present, and Future

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87 - Cost of Growth Valuation and Asset / Earnings Equivalence show art 87 - Cost of Growth Valuation and Asset / Earnings Equivalence

The DIY Investing Podcast

Growth is not free for most companies. It costs something. The cost of growth valuation model takes into account return on invested capital when valuing stocks. Most companies have to retain earnings in order to grow.

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Discounted Cash Flow calculations and models provide precise estimates of intrinsic value but tend to be flawed. It is much better to improve accuracy by ignoring DCF and using a simple intrinsic value calculation like the Gordon Growth Model.

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References:

This episode was inspired by a Twitter thread where I responded to a poll on how to value companies. That thread is available at the following link:

https://twitter.com/TreyHenninger/status/1288475399861817352

Mental Models discussed in this podcast:

  • Cost of Growth Valuation
  • Gordon Growth Model
  • Asset / Earnings Equivalence
  • Retained Earnings
  • Return on Invested Capital
  • Earnings Yield
  • Dividend Yield

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Show Outline

The full show notes for this episode are available at https://www.diyinvesting.org/Episode87

Summary:

Growth is not free for most companies. It costs something. The cost of growth valuation model takes into account return on invested capital when valuing stocks. Most companies have to retain earnings in order to grow.

Assets are only as valuable as the earnings they create. You can't take credit for both book value (assets) and earnings power in the same valuation on a stock. It's a problem of double counting that leads to overvaluation.