{"id":10371,"date":"2022-09-28T09:25:30","date_gmt":"2022-09-28T03:55:30","guid":{"rendered":"https:\/\/www.tickertape.in\/blog\/?p=10371"},"modified":"2022-09-28T09:30:54","modified_gmt":"2022-09-28T04:00:54","slug":"why-taking-a-perpetual-growth-rate-over-3-for-indian-companies-is-a-disaster","status":"publish","type":"post","link":"https:\/\/www.tickertape.in\/blog\/why-taking-a-perpetual-growth-rate-over-3-for-indian-companies-is-a-disaster\/","title":{"rendered":"Why Taking a Perpetual Growth Rate Over 3% for Indian Companies Is a Disaster?"},"content":{"rendered":"\n

To value a business, you need to calculate its terminal value. It is calculated at the end of the growth period, defined as the number of years until a business can grow its profits at a rate that is at least higher than the GDP.<\/p>\n\n\n\n

To calculate a terminal value, we rely on the accounting principle that a company is a going concern assumption; hence we need to assume a growth rate at which a company can keep on growing forever, called the terminal growth rate. Yes, till infinity. <\/p>\n\n\n\n

Even though businesses these days die at a blink of an eye and if we count the number of companies which have survived at least 1000 yrs (which is still technically some 0% of infinity) there are hardly 10 names that Wikipedia throws up. The oldest company is the Japanese construction company Kong\u014d Gumi<\/strong>, founded in 578 C.E. But still, as an analyst, we need to assume a growth till infinity to do discounted cash flows (DCF).<\/p>\n\n\n\n

Now it\u2019s taught in the textbooks that the maximum growth rate you can take for Indian companies is the Indian GDP growth rate because if you take a growth rate higher than that then a single company will become greater than entire India.<\/p>\n\n\n\n

Well, while we agree with this, it also means that the Indian economy can\u2019t grow forever at a rate faster than the world economy growth rate. <\/p>\n\n\n\n

Some people might start arguing India is a developing economy; hence it can grow at a higher rate than the world economy. Yes, we agree, but we are not talking about the coming 50-70-100 yrs, we are talking about till humans survive this planet. Can it still happen? Absolutely not.<\/p>\n\n\n\n

Let\u2019s understand this using some simple calculations<\/p>\n\n\n\n

\"\"\/<\/figure>\n\n\n\n

Forget about infinity even if India grows at a 2% higher rate than the world economy in 200 yrs India will be more than 100% of the world economy. Sounds laughable right? So are the valuation outputs of the financial models that take the perpetual growth rate to be 5% or 6% in their assumptions. <\/p>\n\n\n\n

Hence, if the Indian economy can\u2019t grow more than the world GDP forever, how can a company operating in the Indian subcontinent (whether generating revenue domestically or through exports) grow perpetually higher than 3%? It cannot.<\/p>\n\n\n\n

As terminal value generally contributes more than 50% of current valuations (in 99% of DCF models)<\/em> we recommend anyone using a DCF to value a company to never take the terminal growth rate to be higher than 3%.<\/p>\n","protected":false},"excerpt":{"rendered":"

To value a business, you need to calculate its terminal value. Terminal value is calculated at the end of the growth period, defined as the number of years until a business can grow its profits at a rate that is at least higher than the GDP.<\/p>\n","protected":false},"author":100,"featured_media":10390,"comment_status":"open","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"inline_featured_image":false,"_lmt_disableupdate":"no","_lmt_disable":"no","footnotes":""},"categories":[1770],"tags":[],"acf":[],"modified_by":null,"jetpack_featured_media_url":"https:\/\/www.tickertape.in\/blog\/wp-content\/uploads\/2022\/09\/28-Sep-22-Why-taking-Perpetual-growth-rate-over-3-for-Indian-Companies-is-a-disaster-Guest.png?wsr","_links":{"self":[{"href":"https:\/\/www.tickertape.in\/blog\/wp-json\/wp\/v2\/posts\/10371"}],"collection":[{"href":"https:\/\/www.tickertape.in\/blog\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.tickertape.in\/blog\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.tickertape.in\/blog\/wp-json\/wp\/v2\/users\/100"}],"replies":[{"embeddable":true,"href":"https:\/\/www.tickertape.in\/blog\/wp-json\/wp\/v2\/comments?post=10371"}],"version-history":[{"count":4,"href":"https:\/\/www.tickertape.in\/blog\/wp-json\/wp\/v2\/posts\/10371\/revisions"}],"predecessor-version":[{"id":10392,"href":"https:\/\/www.tickertape.in\/blog\/wp-json\/wp\/v2\/posts\/10371\/revisions\/10392"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/www.tickertape.in\/blog\/wp-json\/wp\/v2\/media\/10390"}],"wp:attachment":[{"href":"https:\/\/www.tickertape.in\/blog\/wp-json\/wp\/v2\/media?parent=10371"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.tickertape.in\/blog\/wp-json\/wp\/v2\/categories?post=10371"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.tickertape.in\/blog\/wp-json\/wp\/v2\/tags?post=10371"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}