How to Calculate Growth in a Stock
- 1). Determine the historical growth of earnings for the past five years. To do this, divide current earnings per share by the previous year's earnings. Average the earnings increase. An example would be a company that earned $5 per share five years ago, and showed steady increases so that this year, the company earns $6.50, or an average of 6 percent per year.
Extrapolate the average earnings five years into the future by multiplying current earnings by the average of the past five years' rates of change, for five more years ($6.50 multiplied by 5 multiplied by 6 percent equals $8.40). - 2). Calculate dividend growth by dividing the current dividend by the previous year's dividend. Do so for the past five years. Take the average dividend increase and project dividends into the future. For example, if a company paid dividends of $1, $1.10, $1.21, $1.33 and $1.46 for the last five years, the average increase would be 10 percent ($1.46 minus $1 equals $0.46; $0.46 divided by 4 is approximately 10 percent).
- 3). Compute historical price/earnings ratios. Use the closing price of the stock for each quarter and divide by the earnings for the previous four quarters. Repeat for the previous five-year period. Compute an average price/earnings ratio from the result. For example, a stock trading at $25 per share that earns $2.50 per share would have a price/earnings ratio of 10 ($25 divided by $2.50).
- 4). Use the average price/earnings ratio computed in step three and multiply the result by the expected earnings derived in step one. The result is the expected stock price for the future year. For example, a stock expected to earn $3 per share four years from now with a historical price/earnings ratio of 14 should trade at a stock price of $42.
- 5). Add the value of dividends projected from step two to the expected stock price derived in step four. The result, stock dividends plus stock price increase, is the total return of the stock. Compare the future total return of a stock to the current stock price to derive a growth rate. For example, a total return of $10 two years from now, when the current price is $40, implies a growth rate of about 12 percent per year. ($10 divided by $40 is 25 percent. 25 percent divided by 2 is 12.5 percent).
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