What's your Growth Rate?

​Given my background and because a number of our members are investment professionals (including Chartered Financial Analysts), I tend to write about investment-related topics fairly often. My perspective on the world is to some extent coloured by my investment training, and I think a number of investment topics have applicability more broadly too – including the focus of this post: our own growth rates.

I also wrote about models (such as financial models) being representations of reality in our post on Professional & Personal Development Cycles. One of the central models in investments is the Dividend Discount Model. It is used, along with other more complex techniques, to value the shares of a company. It is based on the theory that a share is worth the sum of all the company’s future dividend payments, discounted back to today i.e. the net present value of the future earnings that holders of the shares actually receive as dividend payouts.

Read more to explore this valuation model, think about intercepts, slopes and reinvestment, and consider with us a thought experiment on our own professional growth rates and future earnings. Please do build on the ideas mooted in the comments.

Valuing the Future
Models that discount dividends are “absolute valuation” models (as opposed to “relative valuation” models). They aim to find the intrinsic value of an investment based only on that share’s fundamental characteristics such as dividends, the growth rate for that company, its cashflow, its assets etc. 

​The Gordon Growth Model is a formulaic example of the Dividend Discount Model, and it relies on three inputs/parameters:

• The next year’s dividends expected (D) i.e. what the holder of the share expects to receive
• The long-term rate of return required by the shareholder (i), which is impacted by levels of interest rates and perceptions of risk, and is why it is a ‘discount’ model
• The long-term rate of growth in dividends (g), impacted by the company’s industry, strategy, philosophy towards reinvesting in itself, innovation, and so on

The actual calculation is to divide D by i-g to give today’s share value. This means that the value of the share can be increased by: increasing dividends (or earnings actually received), reducing the rate of return required (by, for example, reducing the risk associated with the earnings stream), and/or increasing the rate of growth of future earnings.

There are a number of implicit assumptions in the Gordon Growth Model – this is to be expected given its simple formulation. For example: it assumes that dividends are earned in perpetuity, it assumes they are stable and grow at a constant growth rate, and it doesn’t allow for decay in earnings e.g. if the industry is in decline or the products are becoming obsolete over time. This last point can be adjusted for by reducing the growth rate i.e. dampening the growth in some revenue streams by offsetting the decline in others. Dividend Discount Models also don’t naturally suit companies that don’t pay dividends.

​Intercept, Slope and Reinvestment
Another way to think about the model is as a function/graph with dividends as the ‘intercept’ and their growth rate as the ‘slope’. The most desirable situation would be a high growth rate / slope and a high starting point / intercept.

And, an interesting extension is to consider that the dividends and the growth rate are both impacted by the reinvestment ratio i.e. the proportion of earnings reinvested into growing the business (and hence its future earnings). A higher reinvestment ratio means less dividends now (i.e. less of the earnings are received by shareholders now), but better growth in earnings (and hence dividends) in future, if the retained earnings are invested in successful growth projects.

A Thought Experiment
So now that I’ve set out the Gordon Growth Model of share valuation, the thought experiment that is the focus of this post is as follows: what if we think of ourselves this way? In other words, dispassionately look at our own ‘value’ as merely the present value of our future earnings? Admittedly there is much, much more to our lives in reality, but all models are oversimplifications. There are many intangibles that contribute to our career fulfilment (and broader fulfilment) than simply the paycheck we receive. Putting those aside though, what could we learn from this thought experiment?

Some ideas – please do add yours in the comments below:

• It’s an intrinsic value rather than one derived by comparing ourselves with others
• The value comes from our future potential, rather than our past glories
• We can take action to increase the value: for example, negotiating higher earnings over the next year (such as by demonstrating the value we add to our organisations) or investing now in boosting our long-term growth rate by building future in-demand skills
• Faster growth means more value i.e. what’s our trajectory or ‘slope’?
• A related point is to consider the decay in our skills (as they all have a half-life) i.e. how much longer would an organisation be willing to pay us for those skills, and what can we do to keep them relevant rather than sleepwalk into obsolescence?
• It would also serve us well to think about other organisations, perhaps in other industries, which might value our transferable skills even if they fall out of favour in our current industry
• Our reinvestment ratio (i.e. the proportion of our earnings we reinvest into growth for the future, provided this expenditure isn’t wasteful) is important as it boosts our growth rate
• Education (such as an undergraduate degree or postgraduate study) can help to boost our value, but we should be careful not to offset this by stopping earning for too long or spending too much on the education
• We can think about the present value as proportional to the future assets we might accumulate from our regular saving (after deducting taxes and our living expenses from our earnings) i.e. wealth we’ll accumulate in future as we work and earn
• In reality, our earnings won’t continue forever but will end when we fully retire (voluntarily or not) – finding ways to diversify our earning streams, such as a portfolio career, can help prolong our earnings capacity, similar to how a company might offer various products and/or operate in multiple markets
• Some earnings are not stable (e.g. bonuses, commissions or executive share options) and their unpredictability makes them difficult to anticipate; it is however good to have some exposure to these potential wins as they can be lucrative if they pay off

As one of our coaches says, it’s crucial to have the right mindset about investing in ourselves and not expect someone else to take responsibility for our future. She emphasises: “What sacrifices or tradeoffs are you prepared to make now to enable your future?”