How to Calculate a Company's Earnings Growth Rate

Past earnings are often a good indicator of future earnings, which is why analysts
use earning histories as a valuation tool. This valuation method works best with
what Peter Lynch calls the "stalwarts" -- large companies that still have growth
potential. With earnings histories of ten years or more, the stalwarts have
experienced complete economic cycles of contraction and expansion.

In contrast to the stalwarts, new fast-growing companies frequently have short

earnings histories, and often experience greater earnings volatility. Hence, the
earnings histories of fast-growing companies are less reliable in projecting future
earnings growth.

As for cyclical stocks, as one investment book points out, "valuations based on
earnings can be problematic ... particularly if they are at their high points. The
valuations based on the 10-year historical ratios are probably the most appropriate,
but still pose difficulties for a cyclical company." 1

Finally, in calculating a company's earnings growth rate, "you need to determine

whether growth should continue at that same rate. Studying the firm, its products,
and its competitive environment will help guide your decision to adjust the growth
rate up or down." 2

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1. Maria C. Scott and John Bajkowski, Stock Investing Basics, (Chicago: American
Association of Individual Investors, 1995), p. 72.

2. Scott and Bajkowski, p. 18.

The Calculation
To calculate the growth rate in earnings of a company, let's take the firm Procter &
Gamble as an example. The website MSN Money gives the earnings per share (EPS)
of Procter and Gamble from 2000 to 2009 as follows:

EPS

2009: 3.39

2008: 3.40

2007: 2.84

2006: 2.64

2005: 2.48

2004: 2.15

2003: 1.85

2002: 1.54

2001: 1.03

2000: 1.23

Ten years of data means that we have nine yearly periods of earnings. In the nine
years from 2000 to 2009, Procter & Gamble's earnings per share increased from

1.23 to 3.39. To calculate Procter & Gamble's EPS growth rate over these nine years,
we must first calculate the growth multiple. We do this by dividing the latest
earnings per share number (3.39) by the earliest earnings per share number (1.23):

3.39 / 1.23 = 2.76 (the growth multiple)

Next we raise the growth multiple of 2.76 to the 1/9 power:

(2.76)1/9 = 1.119

(We use the 1/9 power because the time period we are measuring is nine years. If
the time period was five years, we'd raise the multiple to the 1/5 power. If the time
period was three years, we'd raise the multiple to the 1/3 power, etc.)

(If you don't have an exponential calculator to perform the computation, you can
use this Internet calculator:
http://www.rapidtables.com/calc/math/Exponent_Calculator.htm )

Next we take the 1.119 figure and subtract 1:

1.119 - 1 = .119

http://shouldersofgiantsinvestor.tripod.com/growth.html

Finally, we multiply .119 by 100 to get 11.9% as the average annual growth rate.