Varying growth rate application Stock valuation and the implied growth rate You are asked to estimate the future growth in earnings that investors expect for Netflix. Use the current stock price and earnings of Netflix provided below together with the following assumptions: Netflix will experience a high annual growth rate of “x%” for the next 10 years and during this time will continue not to pay dividends. Its first dividend will be 10 years from now. At that time it will payout 60% of earnings as dividends and its long-term dividend growth rate will be 3.7%. Netflix’s equity cost of capital is 8.5%.   What is the short-term growth rate of Netflix as implied by its current stock price?

Financial data

Varying growth rate application The long-term growth rate stabilizes at 3.7% in year 10. Using our earlier notation this implies that “N+1”=10. We can solve this working backwards: The price today is the discounted value of the terminal value in nine years The terminal value is obtained using the dividend growth model The dividend in ten years is 60% of EPS in ten years EPS in 10 years will be higher than current EPS by a factor that takes into account the level of short-term growth “x”

Varying growth rate application Putting it all together implies the following equation: EPS in 10 years Payout ratio Terminal value in 9 years Discounted 9 years back This implies a short-term growth rate of