VARIABLE GROWTH INTRINSIC VALUE (VGIV)
The underlying theory with our VGIV model is gravity, i.e., “what goes up must come down”.
In this model Expected Growth is being affected by gravity.
Companies cannot grow at extraordinary levels forever and over time investment multiples often adjust to lower earnings growth. Companies that are growing their earnings faster than the market’s average earnings growth often trade at premium price multiples. However as a company’s growth slows (as it always does) their price multiples also contract and this can lead to price risk.
Present value models suffer from a number of challenges. For example, how do investors create a value target or a net present value for companies with unsustainable growth forecasts. What about dividends? Is it possible to create an investor payback model (I.E. DDM model) for companies without current dividends? Furthermore, are all equity risk premiums that same? Are the present values of dividends for companies with different risk profiles equivalent?
PIQ’s VGIV model solves for these valuation issues.
VGIV FORECAST
PIQ’s VGIV creates a growth path based on each company’s current growth rate, current earnings, book value and potential dividend trajectory. From this information, a risk adjusted net present value forecast is created.
TERMINAL VALUE INPUTS
VGIV also considers the current market valuations and what those valuations may become in the future, as the company approaches long term market growth. The valuations are based on future Price to Earning, Price to Book Value and future Dividend Yields.
That data used in the VGIV model creates forecasts for each of these metrics. Through this process a stream of future dividends is also estimated. The present value of Terminal Valuations and the stream of future dividends are the ultimate objectives of this modeling. If an investor sells a security based on a future expected multiple, the model calculates the present value of the future price.
PRESENT VALUE AND TERMINAL PROJECTIONS
VGIV assumes a company can or will be sold in the future, the investor will have collected the dividend stream and the future price will be dependent on the future value multiples. The table above highlights the growth in earnings and dividends represented by this value creation. All of these values are discounted at a rate that is dependent on the company’s own specific risk as calculated by the PIQ Volatility Forecast (see below for details).
FUTURE PRICE FORECAST
Each Valuation factor of the model is priced and discounted to its present value and the resulting Intrinsic Value is compared to the current price. In the example above, the model forecasts that Cisco has a Present Value of $55.52 versus its market price of $31.41 today. This suggests an undervalued company.
The PIQ VGIV model solves for investor exuberance by creating a decline path for current and usually overly optimistic growth forecasts. It also forecasts an incline path for payout. This results in specific forecasts for future earnings, book value and dividends. PIQ then calculates a price target based on these forecasts. The forecast sums potential dividend cash flow and calculates a terminal (if sold) value. The model then applies a company specific risk adjusted discount rate to determine the net present value for the future price and dividends. In effect, this is similar to bond pricing or a principle payout model with variable coupons.