PVGO - equity question?

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BMiller12

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If all the earnings are distributed, how is there any PVGO value..where are the earnings needed to generate that future growth in value if no earnings remain to reinvest ?? Or, is the formula suggesting that the E/r portion is the amount of earnings (return) that equals the required return and thus generates an npv=0, and all additional earnings that are/can be positively reinvested over and above ‘r’ are captured by PVGO ? Guess I get confused bc I’m thinking the book suggests that all earnings are distributed, in which case no additional value could accrue to PVGO bc there is nothing remaining to invest. Thanks in advance.
 
I think PVGO is related to the presence of good business opportunities. Normally growth firms have higher PVGO and they do not distribute their earnings. As the PVGO could be negative (like a table given in curriculum and Macys Inc. has negative PVGO) which means that the investors think that the reinvestment should not be done and the earnings must be distributed. Since the company’s investment strategy is not good that’s why investors are valuing it less than its value without reinvestment earnings. I think if a company distributes all its earnings then PVGO should be equal to 0.
Nice question by the way. Any other thoughts please?
 
PVGO is value over E/r. Note that E/r is simply the value of a company that is not growing i.e. PV of a perpetuity. Such would be the case when the company distributes all of its earnings - it would not grow - and hence PVGO is zero. When PVGO is anything other than zero (positive or negative), it does not distribute all of the earnings. If retained earnings are invested in positive npv projects (or market expects it to), PVGO>0. If retained earnings are squadered in negative NPV projects, PVGO<0.
If retained earnings are invested in 0 NPV projects, PVGO would (still) be zero.
 
My question though is, how is the value of E/r determined if the company is growing and reinvesting its earnings?? How are the earnings bifurcated between the E/r and PVGO…surely the E/r value cannot capture all of the earnings, leaving nothing to be reinvested and captured in the PVGO value.
So in the case of reinvestment, does the E/r simply equal the earnigns (dividends) necessary to break even with the required return and everything beyond that is captured in the PVGO ?
I guess maybe since you know the expected earnings and stock price (mkt data), then all you can do is back into the PVGO value, if there is any, becuase no one outside of upper mgt should know what or how to value the companies future opportunities. But back to my original question, if you use the entire earnings figure (E1) in the E/r component, where does the value above that come from ?? Market speculation maybe?
 
there is something subtle in that formula. you are using E0/r if I remember right…. and that part is quite a critical aspect. There is an EOC question which gives you both E1 and E0 and makes you use E0, if I remember right.
Please note that subtlety.
There is also quite a lot of commentary in the book (2-3 pages worth) in the CFAI text. Read it….
 
I did read it. The CFAI text gives an example that says the company is expected to have average EPS of $0.79 if it distributed all earnings as dividends. I assume this means that the company has EPS of roughly $0.79 assuming it distributed all earnings each year, right ??
The example also included a current stock price and required return, from which they derived the PVGO value of $9.85.
My question: if it’s assumed the company distributes it earnings every year (all $0.79 EPS), where does the $9.85 PVGO come from?? Is this the company’s total annual EPS, or is it part of it (the average amount) which goes towards the no-growth portion and the remaining EPS is captured in the PVGO ?
 
if the company distributes all earnings as dividends - that it what it would grow to be… a value of 9.85 - a rate of 8%.
There is an intricate implication - that the earnings stay constant at that number too for perpetuity. (No Growth).
Do a Search of PVG0 - there is a lot of commentary. I remember a couple of years ago on the old site there was some commentary posted. might be helpful to read that. there were questions asked regarding 8C) EOC question. where inspite of being given a growth rate - you have to use the NO GROWTH Assumption to calculate this magic number.
I have forgotten what the implication was, but knew it two years ago when I did take Level II - and this topic just rang a bell. so decided to pass the “torch” so to speak.
 
The textbook frames the topic in the following way:
If you know the current share price or value of a stock, then you can determine the present value of the company’s growth opportunities by calculating the company’s hypothetical no-growth value (E/r, where all of E is distributed). The difference between the company’s no growth value and its market value would therefore be the present value of growth opportunities that have been priced into the company’s stock price (assuming the market has fairly valued the stock, of course).
Hope that clarifies.
 
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