See: Net Present Value.
You run a business selling colored ostrich eggs for Easter. You have some money saved up and want to invest in the company’s growth. There are a few possible opportunities. You could buy a smaller rival that specializes in emu eggs. You could launch a new product, providing cooked ostriches for Thanksgiving dinners.
The stat known as net present value of growth opportunities lets you know which of these potential options to take. To use the figure, you calculate the net present value for each of the potential investments. The process basically boils down each opportunity into a single figure.
Once you have the NPVGO, making the decision becomes easy. If purchasing the emu egg distributor has a NPVGO of $15 million and the ostrich meat product has a figure of $20 million, the ostrich meat product becomes the obvious place to invest.
The NPVGO equation starts by estimating the amount of cash the opportunity will bring in. Then this figure is discounted to take into account a company's cost of capital (which represents the minimum return the company could get by not choosing any investment, and just loaning the money out at market rates). From this, subtract the amount it took to launch the opportunity (either the amount to purchase the competitor or the money you had to invest in the launch product).
Related or Semi-related Video
Finance: What is Price-to-earnings-to-gr...4 Views
Finance Allah shmoop what is priced toe earnings to growth
or a peg ratio You know what the P E
ratio is right And if you don't I'll check out
our fine opus on said Subject Here it's him up
So price here's build a bore Stock trading at forty
bucks a share It had net income or earnings last
year of two bucks a share in trades at yes
twenty times earnings So that's a P and in hee
price and in earnings there it trades at twenty times
earnings Um yeah So what does that mean Well if
it held the earnings flat and basically all of its
earnings was cash earnings Not like some fancy accounting trick
Well if earnings were flat for twenty years well the
company would have made back all of its valuation in
cash profits and everyone would yawn right Twenty years at
two bucks a year twenty times two is forty right
Well that company would have paid up five percent cash
return yield Right Two bucks in earnings over forty bucks
a share to over forty in California and in Texas
is five percent So is that a good return about
return Was there a lot of risk in that number
Growth shrinkage Wealth in a peg ratio Earnings growth is
taken into consideration when evaluating the ratios of a stock
So twenty times earnings is kind of a ho hum
multiple But this company has no growth so that twenty
times is probably a pretty high multiple as a multiple
You know all things considered like twenty years a long
time to get all your money back What if earnings
were doubling each year for the next five years Like
earnings went from two to four to eight to sixteen
to thirty two bucks a share Well then twenty times
earnings was ludicrously cheap Growth was one hundred percent versus
that zero percent where twenty times earnings Look you know
decent Well the basic idea and this one is coined
by Peter Lynch the famed portfolio manager who brought Fidelity
to fame Is that a peg ratio of one means
that a stock is basically fairly priced that is P
E ratios need contexts specifically the context of earnings growth
The formula takes the P E ratio say it's a
twenty and then puts it over the annual earnings per
share growth number and note that it's per share not
just overall company earnings Like if a company grew earnings
by acquiring for stock a lot of competitors well it's
share count would balloon While it's earnings grew fast as
well but likely the dilution and suffered would mitigate most
of the upside in earnings growth So on our twenty
times earnings number a company with no growth gives us
a peg ratio of twenty over zero which is an
undefined number But peg ratio is all about how expensive
the price to earnings ratio is relative to the growth
of the company Wow we did not see that plot 00:02:45.65 --> [endTime] twist coming yellow
Up Next
What are Time-Weighted Rate Of Return and Present Value? The Time Weighted Rate of Return is a calculation for the compounded growth rate within an...