threedistinctscenarios.Inthefirst,thefirmwillmaintainits
high growth rate for a periodof time and thenbecome a
stable-growthfirmabruptly;thisisatwo-stagemodel.Inthe
second, the firm will maintain its high growth rate for a
period and then have a transition period where its
characteristicschangegraduallytowardstablegrowthlevels;
this is a three-stage model. In the third, the firm’s
characteristicschangeeachyearfromtheinitialperiodtothe
stable growth period; this can be considered ann-stage model.
Whichofthesethreescenariosgetschosendepends onthe
firmbeingvalued.Sincethefirmgoesinoneyearfromhigh
growthtostablegrowthinthetwo-stagemodel,thismodelis
moreappropriateforfirmswithmoderategrowthrates,where
theshiftwillnotbetoodramatic.Forfirmswithveryhigh
growth ratesin operating income, a transition phase (in a
three-stagemodel)allowsforagradualadjustmentnotjustof
growthratesbutalsoofriskcharacteristics,returnsoncapital,
andreinvestmentratestowardstablegrowthlevels.Forvery
young firms or forfirms with negative operating margins,
allowingforchangesin eachyear(inan n-stagemodel) is
prudent.
Can you have high-growth periods for firms that have
expectedgrowthratesthatarelessthanorequaltothegrowth
rateoftheeconomy?Theanswerisyes,forsomefirms.This
isbecausestablegrowthrequiresnotjustthatthegrowthrate
belessthanthegrowthrateoftheeconomy,butthattheother
inputs into the valuation are also appropriate for a
stable-growth firm. Consider, for instance, a firm whose
operatingincomeisgrowingat 4 percentayearbutwhose
currentreturnoncapitalis 20 percentandwhosebetais1.5.
Youwouldstillneedatransitionperiodwherethereturnon