Terminal growth rate

The rate at which cash flow is assumed to grow forever after the explicit forecast ends. Sits in the denominator of the terminal value formula alongside the discount rate.

Example

Raising it from 2.5% to 3.5% lifted an enterprise value from 15,928,152 to 17,834,269, a rise of 12.0%.

Important

It cannot exceed the long-run growth of the economy the business sells into without implying the business eventually becomes that economy. Anything above about 3% is a strong claim, not a neutral default.

Related terms

• Terminal value — The value assigned to everything beyond the explicit forecast period, most often by assuming the final forecast year's cash grows at a constant rate forever.
• Gordon growth model — The relationship that values a growing perpetual income stream as next year's income divided by the required return less the growth rate. The same formula produces a terminal value and a capitalisation rate.
• Sensitivity analysis — Recomputing a valuation with each uncertain input moved across the range you would defend, to see how much the answer depends on each one.

Lessons that explain it

• Discounted cash flow: the method that shows its assumptions — A discounted cash flow states every assumption out loud, which is its great virtue and the reason it is so easy to abuse. The output moves enormously on inputs that cannot be observed. (14 min)
• Work backwards: what would have to be true to justify this price? — Rather than producing your own valuation and comparing it with the price, take the price as given and solve for the growth or margins it assumes. Then judge whether those assumptions are plausible. (11 min)

All 578 terms in the Investing glossary