Estimating Growth in Value Investing
Avoid using valuation based on growth estimates
Another reason for pure value investing’s aversion to valuation based on growth estimates is that growth’s potential value can be ascertained using other accounting tools not requiring estimates.
This involves comparing valuation estimates using earnings with those using assets.
Three possibilities arise: The valuations are the same or one or the other is higher.
1. Earnings value = Asset value
When they are the same, growth bears no value as just noted.
2. Asset value > Earnings value
When asset value exceeds earnings value, managers are deploying assets sub-optimally, either due to ineptitude or excess industry capacity. No value resides there.
3. Earnings value > Asset value
When earnings value exceeds asset value, it is due to competitive advantages or barriers to entry, and these clues indicate potential value in growth. This indicates a company possessing franchise value. One measure of that value is the excess of earnings value over asset value. It is captured in the expression return on equity. This economic goodwill makes companies value investor candidates.
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