What Is a Growth Rate?
What Is a Growth Rate?
A growth rate measures the percentage change in a company's earnings or revenue over time, and it can be calculated from historical results or estimated for future periods. It's one of the most commonly cited figures in investing, and it's the input that does the most work, and carries the most uncertainty, in Graham's intrinsic value formula.
Where EPS and shareholder equity are both backward-looking, pulled directly from a company's published financial statements, a growth rate used in valuation is usually forward-looking: an estimate of what's expected to happen next, not a fact about what already happened. That distinction matters more than it might seem, and it's the reason growth rate deserves its own explanation separate from the harder accounting figures.
How It's Calculated (Historical Growth)
The simplest version, historical earnings growth, looks like this:
Growth Rate = [(Ending Value − Starting Value) ÷ Starting Value] × 100
Take a company that earned €1.80 per share last year and €2.00 per share this year:
[(2.00 − 1.80) ÷ 1.80] × 100 = 11.1%
That's a straightforward year-over-year growth figure. Analysts often extend this over multiple years too, using a compound annual growth rate (CAGR) to smooth out any single unusually strong or weak year, which gives a more representative average growth figure over a longer stretch.
Historical Growth vs Expected Growth
This is the distinction that matters most for anyone using a growth rate in a valuation formula like Graham's.
Historical growth is a fact. It's calculated from real, already-reported figures, and it tells you what actually happened over some past period.
Expected growth is a forecast. It's an estimate of what will happen over some future period, usually the next several years, and it can come from a few different places: a company's own guidance to investors, published analyst estimates, or simply extrapolating the historical growth rate forward on the assumption that past performance continues.
None of these sources are guaranteed to be accurate. Analyst estimates get revised regularly and are frequently wrong, sometimes by a wide margin. Company guidance is provided by the company itself and can be overly optimistic. And extrapolating historical growth assumes the future will look like the past, which is often not true, especially for younger or fast-changing companies.
Why It Matters So Much in Graham's Formula
In the intrinsic value formula, the growth rate isn't calculated by the formula itself, it's an input the user has to supply, and the formula is highly sensitive to it. A small change in the assumed growth rate produces a large change in the calculated intrinsic value, because the growth term is multiplied through the rest of the equation rather than added as a minor adjustment.
This is exactly why the intrinsic value article's limitations section treats the growth rate assumption as the single biggest source of uncertainty in the whole calculation. The formula itself is simple arithmetic; the real difficulty is deciding what growth number belongs in it.
It's also worth remembering that a growth rate is a compounding rate. A company growing earnings at 6% a year versus 10% a year sounds like a modest difference, but compounded over the seven to ten years this formula projects, the gap between those two outcomes is much larger than it first appears.
How to Choose a Reasonable Growth Rate
There's no single correct source, but a few reasonable approaches:
A conservative approach uses a company's historical earnings growth rate over the past five to ten years, on the logic that a long track record is harder to fake than a single optimistic forecast, even though it's no guarantee of future results either.
A market-based approach uses published analyst consensus estimates, typically available through financial data providers, which reflects a blend of professional opinion rather than a single source's guess.
A cautious approach deliberately uses a lower growth rate than either of the above, sometimes called a "haircut," to build in a margin of safety against overly optimistic assumptions, consistent with Graham's broader conservative philosophy.
Whichever approach is used, running the calculation with more than one growth rate, rather than treating a single figure as correct, gives a more honest picture of how sensitive the result actually is.
Limitations
The core limitation is the one already covered: growth rate is a forecast, not a fact, and the intrinsic value formula treats it with more precision than a forecast deserves. A single growth rate assumption produces a single, specific-looking euro figure, which can create a false sense of accuracy about what is ultimately an educated guess.
It's also difficult to apply consistently across companies. A mature, slow-growing utility company and an early-stage growth company require very different growth assumptions, and using the wrong kind of estimate for the wrong kind of company (extrapolating a young company's early high growth rate indefinitely, for instance) tends to produce unrealistic results.
FAQ
What growth rate should I use in the intrinsic value formula?
There's no single correct source. A conservative approach uses the company's historical earnings growth over the past five to ten years, a market-based approach uses published analyst consensus estimates, and a cautious approach applies a haircut below either to build in a margin of safety. Whichever you choose, run the calculation with more than one growth rate to see how sensitive the result is.
Is historical growth a good predictor of future growth?
It's a reasonable starting point, since a long track record is harder to fake than a single forecast, but it's no guarantee. Extrapolating past growth assumes the future will look like the past, which often fails for younger or fast-changing companies.
Nothing on this site is financial advice. It's a personal record of my own research and decisions, shared for transparency, not as a recommendation to buy or sell anything.