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Shaun Cornell

Ranking on Growth Options

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Related to our recent posts on the role of growth options, we though it would be interesting to rank US equities based on the percentage of market value attributable to growth options as opposed to assets in place.  In the interest of simplicity (and access to necessary data) we use a simple “back of the envelope” method for computing the value of assets in place.  The value of the growth options is then the difference between the market capitalization and the value of the assets in place.

Specifically, we estimate the value of the assets in place as the forecast of earning for the next fiscal year divided by the cost of equity minus the inflation rate.  (We assume that everything grows at rate of inflation.)  Mathematically, we used the equation

Market Value per Share = Forecast earnings per share/(R – inflation) + Value of growth options.

Finally, using data for November 9, 2018, we calculated the percentage of the market value accounted for by growth options.  In doing the calculations, we limited the sample to companies with a market capitalization of at least $5b that are traded on US exchanges and for which EPS estimates were available from Sentieo.

The link below is to a spreadsheet of the results with companies ranked in order of the percentage of their market value due to growth option.

It is interesting to note that there are a number of companies whose portion of growth options exceeds 100% of their market value.  Conversely, there are even more whose growth options have negative value, indicating the market believes their future is bleak.

Not surprisingly, the top of list is heavily populated with bio-tech companies, where the outcome of future treatments or drugs can have a dramatic effect on value. Also, many of our “Top Ten Bubble Stocks” appear near the top as well.

As we wrote in our post on ROKU, companies with a high percentage of value in growth options are likely to be especially sensitive to news suggesting slowing growth. Consequently, investors who hold companies near the top of the list may want to be especially cautious.

Percentage of Value due to Growth Options Spreadsheet


ROKU : Growth Options and Bubble Stocks

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ROKU, a member or our “Top Ten Bubble Stocks (that could drop 50% or more)” list that we published in early October, reported earnings yesterday. Despite beating both top and bottom line earnings estimates, the stock was down a staggering 22% today.

We have talked extensively about “growth options” on this blog.  (High Expectations Can Bring Big Risks).  Recall that a firm’s equity value can be thought as being comprised of two components: 1) The value of current operations (which includes 5 years of future expected growth) and 2) everything else which is the “growth options”.  For tech companies like Roku, the growth options often include distant future opportunities that investors envision.

ROKU’s value is largely based on the 2nd components – the growth options. Companies whose value depends primarily on growth options can be highly sensitive to even a whiff of slowing growth.  That was the case with ROKU.  Despite the good top and bottom line performance, the earning release foreshadowed slowing user growth.  The related decline in the value of the growth options swamped any good news about current operations, sending the stock down 22%.  This underscores the need for caution among those considering investment in companies whose value is largely dependent on growth options.