Equity Valuation and Portfolio Management

FRANCHISE VALUATION UNDER Q-TYPE COMPETITION

In the two-phase growth model, we assumed that the firm with 12.4% growth (see Exhibit 3.8), transitioned after 10 years to a more stable 7.4% growth rate. This model is generally intended to reflect an initial span of growth and prosperity followed by a second-phase regression to a competitive equilibrium. This terminal stage can be construed as the period when sales growth stabilizes but the company's earnings continue to change as the pricing margin moves toward some competitive equilibrium. This margin-equilibrating process can usefully be described in terms of the ratio of asset replacement costs to the company's economic book value, B, and is related to Tobin's q.⁵

The valuation impact of this terminal-phase effect will depend totally on the nature of the company's business and its long-term competitive posture. Some companies will be positioned to gain from post-growth margin expansion. For some businesses, growth itself builds a relatively unassailable efficiency of scale with distinct organizational, distributional, and technological advantages. Patent protection and/or extraordinary brand acceptance may assure franchise-level margins for years to come. Leading-edge products may themselves act as germinators for subsequent generations of even more advanced products. For such fortunate companies, potential competitor's cost of building a new enterprise and comparable revenue stream might far exceed the existing firm's economic ...