Growth Rates In Accounting Measures

Growth Rates In Accounting Measures

When we track the firm’s growth using accounting measures, then we get five different growth rates for the same firm:

Revenue growth,
EBITDA growth
EBIT growth
PAT growth
EPS growth

Further analysts compute growth in net income with and without extraordinary items and EPS growth on primary and diluted outstanding shares. Given all of these different earnings measures, it is not surprising that we mix them up and think that growth in one step is growth in the others.

For example, i have observed analysts assume the growth rate in EPS used as the growth rate in EBIT in #DCF valuations. In my view, this assumption holds when growth happens in one measure and stays constant in others. Let me explain.

1)When a firm improves its operating efficiency, #EBITDA growth exceeds sales growth for a given sales growth.

2) Small changes in revenues can translate to significant changes in #EBIT for a firm with higher fixed assets.

3) Higher interest costs with a higher debt to equity ratio can make equity earnings (net income and EPS) more sensitive to changes in operating income.

4)If the company issues equity or does buyback, the EPS growth differs from net income. Lately, as more companies do a buyback, EPS growth increases not due to improved operating performance but lower share count.

5) As companies have significant cash or cross holdings, non-operating income plays a substantial role in #EPS growth.

Thus, while valuing companies, i focus on specifics when there are changes in operating efficiency, operating leverage, financial leverage, and dividend policy. In other words, an EPS growth rate metric that investors widely use to track their returns does not indicate the growth in value of a firm when firms change their dividend/buyback policy or report higher non-core income.