What Is NPVGO (Net Present Value of Growth Opportunities)?
NPVGO is the per‑share present value of a firm’s future profitable growth projects (new investments, projects, acquisitions) net of the cost to undertake them. It isolates the portion of a company’s intrinsic per‑share value that comes from expected future growth rather than from current, no‑growth earnings.
Source: Investopedia — https://www.investopedia.com/terms/n/npvgo.asp
Why it matters
– Helps distinguish how much of a stock’s price is driven by today’s earnings versus the market’s expectations for future growth.
– Useful for acquisition pricing, project selection, negotiating deals, and understanding valuation risk from growth assumptions.
– Makes explicit the value (or cost) of reinvesting earnings rather than paying them out as dividends.
Basic relationship and formulas
– Conceptual: Price per share (P0) = Value of current (no‑growth) earnings per share + NPVGO
– Value of current earnings (no growth) = EPS / r (where r = cost of equity)
– NPVGO = P0 − (EPS / r)
– More generally, NPVGO = PV of incremental cash flows from growth projects (per share) − initial investment (per share)
Note on assumptions: Using EPS/r as the no‑growth value assumes earnings could be paid out as dividends and discounted at the cost of equity. When cash flows or payouts differ, use the appropriate cash flow definition and discount rate (e.g., firm free cash flow discounted at WACC).
Step‑by‑step: How to calculate NPVGO (practical)
1) Choose the perspective and discount rate
– Equity perspective (per share): use cost of equity (r) and incremental cash flows to equity.
– Firm perspective: use WACC and incremental free cash flows to the firm, then divide by shares outstanding to get per‑share NPVGO.
2) Define the “current earnings” baseline
– Decide a no‑growth baseline (e.g., current EPS paid as dividends).
– Compute value of current earnings: Baseline value = EPS / r.
3) Identify growth opportunities and forecast incremental cash flows
– List projects, acquisitions, R&D, geographic expansion, product launches.
– Project incremental annual cash flows (to equity or to firm) attributable to these initiatives.
– Exclude nonrecurring, discontinued, or accounting distortions.
4) Estimate the cost to implement
– Record required investments (capex, working capital, acquisition price) net of any divestitures; express per share if working per share.
5) Discount incremental cash flows to present value
– Discount each year’s incremental cash flow at the chosen discount rate.
– Sum discounted incremental cash inflows and subtract discounted investments (or subtract initial investment up front).
6) Compute NPVGO per share
– NPVGO = Present value (PV) of incremental growth cash flows per share − PV of incremental investment per share (or simply PV of net incremental cash flows per share).
– Or, if you know P0: NPVGO = P0 − (EPS / r).
7) Interpret and test sensitivity
– Positive NPVGO: market/value attached to profitable growth opportunities.
– Negative NPVGO: growth projects destroy value or market expects value decline.
– Run sensitivity analysis on discount rate, growth rates, ROIC/ROE, and cash flow forecasts.
Worked example (from Investopedia)
– Given:
– Intrinsic (calculated) stock value P0 = $64.17
– Cost of capital r = 12% (0.12)
– EPS = $5.00
– Expected earnings from future growth opportunities (next year) = $0.90
– Growth rate of those growth‑derived earnings g = 8% (0.08)
– Value of current (no‑growth) earnings = EPS / r = $5 / 0.12 = $41.67
– Value of growth opportunities (using a Gordon‑type perpetuity on the incremental earnings): value = 0.90 / (0.12 − 0.08) = $22.50
– Total intrinsic value = $41.67 + $22.50 = $64.17
– Therefore NPVGO = $22.50 per share (this is the PV of all future growth opportunities per share)
Practical tips and caveats
– Use consistent definitions: If you use EPS you implicitly assume equity cash flows; if you use firm free cash flow, use WACC and convert to per‑share basis by dividing by shares outstanding.
– Exclude one‑time items: Remove discontinued operations, unusual gains/losses, and other nonrecurring items from earnings and growth forecasts.
– Consider financing and dilution: New equity or debt to fund projects can change per‑share NPVGO (dilution, interest expense, tax effects).
– Be conservative with perpetual growth assumptions: If you capitalize incremental earnings as a perpetuity (C1/(r − g)), ensure g < r and that g is sustainable.
– Sensitivity analysis: Small changes in r or g can have large effects on NPVGO—test multiple scenarios.
– Industry context: High‑growth sectors (tech, biotech) typically have higher NPVGO as a share of value; capital‑intensive or mature industries have lower NPVGO.
How investors and managers use NPVGO
– Investors: Gauge how much of a stock’s price depends on growth expectations vs. current earnings. High NPVGO implies greater risk if growth disappoints.
– Acquirers: Estimate incremental per‑share value an acquisition would add (or subtract) to the buyer’s shares.
– Management: Decide whether to retain earnings and invest or to return capital—compare expected project NPV with shareholder alternatives.
Checklist before relying on an NPVGO estimate
– Are projected cash flows realistic and well‑sourced?
– Have you used the correct discount rate for the type of cash flow?
– Did you remove nonrecurring/one‑off items from forecasts?
– Did you account for taxes, working capital needs, and maintenance capex?
– Did you model financing effects and potential dilution?
– Have you stress‑tested the estimate across scenarios?
Common pitfalls
– Treating accounting earnings as equivalent to cash flows without adjustments.
– Using an inconsistent discount rate (e.g., using WACC for equity cash flows).
– Relying on perpetuity formulas with unrealistic long‑term growth rates.
– Forgetting the opportunity cost of capital or shareholder alternative returns.
Further reading
– Investopedia: Net Present Value of Growth Opportunities — https://www.investopedia.com/terms/n/npvgo.asp
– Standard corporate finance textbooks on valuation, dividend discount models, and the NPV rule.
Summary
NPVGO splits a firm’s per‑share intrinsic value into the value of current earnings (no growth) and the value attributable to future profitable growth. Calculating it requires clear definitions of cash flows, an appropriate discount rate, and careful assumptions about future projects. Used properly, NPVGO gives a focused measure of how much growth expectations drive a company’s value and helps inform investment, acquisition, and capital allocation decisions.