We have prepared this PVGO calculator for you to calculate the value of a company's future growth. PVGO (present value of growth opportunities) is also a very useful metric used in company valuation. It associates a company's share price with the value of its future growth opportunities.
We have written this article to help you understand what PVGO is and how to calculate it using the PVGO formula. To quickly understand the concept, we have prepared some examples to show you the calculation process. Next, we will discuss the PVGO concept in more detail.
What is PVGO?
PVGO, also known as the present value of growth opportunities, is essentially the value of a company's growth. It is a metric used to measure how much value a company can create by investing in future projects.
In a PVGO model, a justified company's share price is equivalent to the sum of the present value of its most recent earnings and its PVGO. In essence, it defines a company's share price as its current value plus the present value of all its growth.
If it sounds complicated, do not worry. The concept will become a lot clearer once we deep dive into the PVGO calculation.
How to calculate PVGO?
Now, let us attempt to calculate the PVGO of Company Alpha, which reports the following information:
- Share price: $20.00
- Current earnings: $2,000,000
- Number of shares outstanding: 1,000,000
- Cost of equity: 12.5%
- Determine the share price of the company.
We can obtain the
share priceof the company from various online sources such as Google, Yahoo Finance, Bloomberg, etc. Don't worry, most of the time, they are reliable and accurate.
For our example, the
share priceof Company Alpha is
- Determine the company's earnings per share (EPS).
Earnings per share, or
EPS, is defined as the
earningsof the company divided by its
number of shares outstanding.
EPS = earnings / number of shares outstanding
EPSof Company Alpha is:
$2,000,000 / 1,000,000 = $2.
- Calculate the cost of equity.
cost of equityis the return required by investors by investing in that particular company. The most widely used method to calculate is using the capital asset pricing method (CAPM).
In our example, the cost of equity is assumed to be
- Calculate the present value of growth opportunities (PVGO).
The final step is to calculate the present value of growth opportunities using the PVGO formula as follows:
PVGO = share price - EPS / cost of equity
PVGOof Company Alpha is:
$20 - $2 / 12.5% = $4.
What is PVGO useful for?
Now that we understand the PVGO calculation, let's discuss how we should interpret the present value of growth opportunities.
PVGO helps companies make a critical decision about whether or not the company should reinvest its earnings or distribute the earnings to the shareholders. If the PVGO is less than or equal to zero, the company does not have any growth opportunities that will increase the value of the company. Thus, distributing all of its earnings back to its shareholders will be a better choice. On the other hand, if the PVGO is larger than zero, the company should reinvest its earnings as it can generate more value to the shareholders this way.
However, an accurate PVGO assumes that the share price of the market is fairly valued. This is a risky assumption as the share price of a company are often very volatile. So, it is always recommended taking the share price as a 1-year average share price instead of the current share price.
What does a negative PVGO mean?
A negative PVGO means that by reinvesting the company's earnings, the company will actually decrease in value. Hence, a company with PVGO should distribute all its earnings to its shareholders as dividends.
What is cost of equity?
The cost of equity is the return investors required by investing in that particular company. The higher the risk of the company, the higher the required return of the investors, hence the higher the cost of equity.
How should I interpret PVGO?
A high PVGO means that a company has a lot of growth opportunities that it can pursue, which would increase the company's value in the future. Thus, the higher the PVGO, the more earnings should be invested back into the business as it might generate more value for its shareholders than giving them out as dividends.
What is prevent value?
The present value is the current value of the future cash flow. It is calculated by discounting future cash flows back to the present using a pre-determined interest rate.