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To figure this out, we have to calculate the compound average growth rate(CAGR) for several time periods over the past 10 years. It’s a pretty simplecalculation.Let’s say the most recent data we have is 2010. We’ll call that Year 10. 2001 willbe Year 1. Here are the time periods we need to calculate their CAGR:Year 1 to Year 8Yr 2 to Yr 9Yr 3 to Yr 10Yr 1 to Yr 6Yr 3 to Yr 8Yr 4 to Yr 9Yr 5 to Yr 10To calculate the CAGR for each time period, the formula is:(Yr 8 / Yr 1)
(1/ # of years between Yr 8 and Yr 1)
- 1For example, if Yr 8’s Free Cash Flow was $1,000 and Yr 1’s FCF was $500, thecalculation would look like this:(1000/500)
= 0.104That gives us a CAGR of 10.4% from Year 1 to Year 8.Calculate the CAGR for each of the time periods above. If either the first or lastyear of the time period is negative, make the CAGR 0% for that time period.Take the average of the two median CAGRs. We’ll use this number as a base toproject the company’s future free cash flow.
2. How will the Company Perform in the Future?
This is a difficult question to answer. That’s why it’s vital to be conservative inyour estimate of future growth, since growth generally fades over time. “A recentarticle in the
Financial Analysts Journal
confirmed...that the fastest-growingcompanies tend to overheat and flame out.” (pg. 305 of
The Intelligent Investor
by Benjamin Graham)We recommend capping the growth rate you calculated above for that veryreason.At Vuru, the growth rate we use is capped at 11.25% and we slow it down as theyears pass, as it’s likely that growth will slow over the years, as stated above.