CFA Institute

Compound Interest and Annuity Tables: And Their Use in Equity Valuation and Portfolio
Management
Author(s): W. Edward Bell
Source: Financial Analysts Journal, Vol. 20, No. 3 (May - Jun., 1964), pp. 111-117
Published by: CFA Institute
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 COMPOUND INTEREST AND ANNUITY TABLE
and their use in
Equity Valuation and Portfolio Management
by W. Edward Bell

THIS ARTICLE will be of interestprimarilyto financial rate i addedat the end of each year. If interestis com-
analystswho have not becomefully accustomedto pounded annuallyat 5%, the value at the end of one
the use of compoundinterest and annuitytables. year is $1.00 times 1.05; at the end of the second year
Some of the illustrationsmay also interest more ex- the value or compoundamountis $1.00(1.05)(1.05).
periencedanalysts. Whileintroductoryand by no means The generalized formula is (1 + i) n, where i is the
exhaustive, the presentationshould assist readers in interestrate per period and n is the numberof periods.
acquiringa fullergraspof the characteristicsof standard Since the initialsum is rarely$1.00, we simplymultiply
tables and facilityin their use. the initial amount by the appropriatefactor shown in
For convenientreference,we include a set of con- the table. Thus, $10,000 investedfor five years at 5%
densedtables (see page 113). These are most detailed compoundedannuallywill be worth $10,000 (1.2763)
for the compound amount function (Table A). The or about$12,763 at the end of five years. We will later
compound amount is shown for twelve rates ranging illustratehow our condensedTable A can be used for
from 21/2% to 25 %; for many purposesintermediate time periodsnot shown, such as 18 years or 75 years.
values derivedby interpolationwill be sufficientlyaccu- For interestrates not shown one can interpolateif an
rate. While the present value and annuity functions approximationis adequate;otherwiseone must refer to
(Tables B, C and D) are much more condensed,other detailedtables, use a log-log slide rule at some expense
values can be readilydeterminedfrom Table A with a of precision,or use logarithms.
calculatoror slide rule. For our purposestablesto four EXAMPLE 1. Mr. Smithestablishesa $5,000 educa-
or five significantfiguresare adequate. Where precise tional fund for his five-year-oldgrandson. Income will
computationsare required,as in settling an obligation, be reinvested. What will be the value of the fund in
tables to more decimalplaces should be used. (Copies 12 years, assumingan averagereturnof 6% including
of the condensedtablesmay be obtainedfromthe writer both incomeand appreciation?
on request.)
The values shown for the presentvalue and annuity Solution. TableA showsthat $1.00 compoundedfor
functions were selected as those especially useful in 12 years at 6% will become $2.0122; $5,000 will be-
some approachesto comparativeequity valuation. A come $5,000(2.0122) or $10,061. This could be
very brief introductionto this subjectis includedin the roundedto $10,000.
present article. The writer is preparinga somewhat EXAMPLE 2. After 12 years the initial $5,000 fund
fuller treatmentof equity valuationwhich will appear in Example1 has increasedto $13,750. Whathas been
in an early issue of the Financial Analysts Journal. the averageannual return,includingboth income and
appreciation?
Compound Amount of 1-(Table A)
Solution. Divide $13,750 by $5,000; the quotientis
Nearly everyone is familiar with the compoundin- 2.75. Reading horizontallyin Table A from n 12,
terest table. This shows the value which $1.00 will you find that 2.75 falls between2.5182 (for 8%) and
become after n years (time periods) with interest at 2.8127 (for 9% ) andis muchcloserto the latter. Thus,
the averageannualreturnwas just under9%. (As we
W. Edward Bell is a vice president of Crocker-Citizens will illustrate,Table B could also be used.)
National Bank and is president of The Security Analysts
of San Francisco. He is coordinator of a course in Invest- EXAMPLE 3. In negotiatingthe sale of a privatecom-
ment Analysis and Management jointly sponsored by the pany, you are offered the alternativeof $50,000 cash
San Francisco society and University of California. He is now or $70,000 cash to be paid withoutinterestin five
author of "The Price-Future Earnings Ratio," Financial years. You decide to take the cash now unless the
Analysts Journal, August 1958. Mr. Bell has an M.B.A.
degree from Stanford University and is a Chartered deferredpaymentoffers a returnof 8% or better.
Financial Analyst. Solution. Divide 70 by 50; the quotientis 1.40. From
MAY-JUNE 1964 111

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Table A you find that the returnis just under7%. The EXAMPLE 7. A client plans to set up a fund for the
deferredpaymentis rejected. college expensesof her grandchildren.The objectiveis
EXAMPLE 4. What will be the value in 18 years of
a fund of about $25,000 in 15 years. Net income will
$10,000 investedat an averagereturnof 6%? be reinvested. If you assumean averageannualreturn
of 7%, includingboth income and appreciation,what
Solution. Our condensed Table A does not show initial amountis required?
values for n - 18. But consider that (1.06)18
(1.06)15(1.06)3. Thus, we have 2.3966(1.1910) Solution. Table B shows that the present value of
$1.00 in 15 years at 7% compoundinterest(discount)
2.8543506. We should roundthis to 2.8544, since our
is $0.3624. The required present fund is $25,000
table values are to five significantfigures. The answer
is $28,544.
(.3624), or just under $9,100.
EXAMPLE 8. Miss Foster has expert advice that her
EXAMPLE 5. A company states that total industry
sales of their majorproductshould grow at about 7% tract of unimprovedland should be worth at least
per year for at least five years; also that the company's $75,000 in 10 years. The best currentofferis $20,000.
shareshouldincreasefrom 15% to 18% of the industry Should she sell?
in the five years. The industry'ssales of the productare Solution. Divide 20 by 75 to determinethe discount
now $3,000 million. What will the industry'ssales be factorfor Table B; the quotientis about .267; since this
in five years? What will the company's sales of the does not appearfor n - 10 in our condensedTable B,
productbe? What rate of growthof companysales is we may take the reciprocalof .267 (or 1/267); more
implied? directly, divide 75 by 20. The compound amount
Solution. In five yearsindustrysales wouldbe $3,000- (Table A) factor is 3.75. For n_ 10 this indicatesa
(1.4026) millionor $4,208 million. At 18% the com- returnof about 14%. The decisionas to whetheror not
pany'ssharewould be $757 million. Companysales of to sell the real propertywould also dependon taxes and
the productare now $450 million. The impliedgrowth other costs, alternativeinvestmentsavailable(including
rate for companysales is about 11% per year. (This the level of stock prices), the reliabilityattributedto the
could be computedmore preciselywith the log-log slide projectedvalue of the property,considerationsof tem-
rule if any useful purposeis served.) peramentand preference,and so forth.
As we have indicated,Examples2 and 3 can also be
EXAMPLE 6. As an exercisein imagination,consider solved using the discounttable (B); in both cases the
$1,000 investedat 5% compoundedfor 175 years.This presentvalue wouldbe dividedbv the futurevalue. The
can be reducedto present value is the base or divisor in compounding
$1,000 (1.05) 50 (1.05) 50 (1.05)30 (1.05) 25, (Table A); the future value is the base or divisor in
and to (from Table A) discounting(Table B). We have seen that the com-
$1,000 (11.467) 3 (3.3864) pound amount factor can be used for discountingby
invertingthe fraction.
The answeris approximately$5,106,000. Another 50
years (225 years in all) would bringthe initial $1,000 Amount of an Annuity of 1 per Period
to nearly $59 million. In 500 years at 5%, $1,000 Present Value of an Annuity of 1 per Period
would exceed $39 trillion! This may suggest why we
have laws againstperpetuities. Consideralso the very (Tables C and D)
rapid compounding at high rates such as 10% or The annuityconceptis somewhatmore complexthan
above. It is evident that one must use caution in pro- compoundingand discounting.The formulas,shown at
jectinghigh growthratesfor very many years. the top of Tables C and D, are developedin any text-
Present Value of 1-(Table B) book on the mathematicsof finance. First, we will
definethese concepts.
Presentvalue tables converta futuresum to its pres-
ent value on the basis of a given rate of discount The amount(or sum) of an annuity(Table C) is the
(interest) per year (time period) and a given number value at the end of n years (time periods) of a series of
of years.Compounddiscountis analogousto compound equalpaymentsmadeat the end of each year,with com-
interest. pound interestat rate i accumulatedfrom the time of
If a presentsum of $1,000 is worth $1,000(1.4775) each paymentto the terminaldate.
or about$1,478 in eightyearsat 5% compoundinterest The present value of an annuity (Table D) is the
(Table A), it follows that $1,478 due in eight years is value at the beginningof n years (time periods) of a
now worth $1,000, discounted at 5%. Referring to series of equal paymentsmade at the end of each year,
Table B, we have $1,478(.6768), or about $1,000. with each payment discountedto its present value at
Note the reciprocalor inverse relation between the compoundrate of interest(discount) i.
formulasandvaluesfor TablesA andB. Missingvalues We shall be concernedwith time periods of one or
in Table B can be quickly determinedby dividingthe more full years and with interestcompoundedannually.
correspondingTable A value into 1. More directly, This article will not cover problems involving com-
Table A values can always be substitutedfor Table B poundingintervalsdifferentfrom the payment period
by dividinginsteadof multiplying. nor with annuitiesdue, in which the paymentis made
112 FINANCIAL ANALYSTS JOURNAL

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 INTERESTAND ANNUITYTABLES
COMPOUND
CONDENSED

Table A
Compound Amount of 1: (1 + i)

n 2?7% 4%. 5% 6% 7% 87.j 9% 10 71 15%- 207. 257

1 1.0250 1.0400 1.0500 1.0600 1.0700 1.0800 1.0900 1.1000 1.1250 1.1500 1.2000 1.2500
2 1.0506 1.0816 1.1025 1.1236 1.1449 1.1664 1.1881 1.2100 1.2656 1.3225 1.4400 1.5625
3 1.0769 1.1249 1.1576 1.1910 1.2250 1.2597 1.2950 1.3310 1.4238 1.5209 1.7280 1.9531
4 1.1038 1.1699 1.2155 1.2625 1.3108 1.3605 1.4116 1.4641 1.6018 1.7490 2.0736 2.4414
5 1.1314 1.2167 1.2763 1.3382 1.4026 1.4693 1.5386 1.6105 1.8020 2.0114 2.4883 3.0518

6 1.1597 1.2653 1.3401 1.4185 1.5007 1.5869 1.6771 1.7716 2.0273 2.3131 2.9860 3.8147
7 1.1887 1.3159 1.4071 1.5036 1.6058 1.7138 1.8280 1.9487 2.2807 2.6600 3.5832 4.7684
8 1.2184 1.3686 1.4775 1.5938 1.7182 1.8509 1.9926 2.1436 2.5658 3.0590 4.2998 5.9605
9 1.2489 1.4233 1.5513 1.6895 1.8385 1.9990 2.1719 2.3579 2.8865 3.5179 5.1598 7.4506
10 1.2801 1.4802 1.6289 1.7908 1.9672 2. 1589 2.3674 2.5937 3.2473 4.0456 6.1917 9.3132

11 1.3121 1.5395 1.7103 1.8983 2.1049 2.3316 2.5804 2.8531 3.6532 4.6524 7.4301 11.642
12 1.3449 1.6010 1.7959 2.0122 2.2522 2.5182 2.8127 3.1384 4.1099 5.3503 8.9161 14.552
15 1.4483 1.8009 2.0789 2.3966 2.7590 3.1722 3.6425 4.1772 5.8518 8. 1371 15.407 28.422
20 1.6386 2. 1911 2.6533 3.2071 3. 8697 4. 6610 5.6044 6.7275 10.545 16.366 38.338 86. 736
25 1.8539 2.6658 3.3864 4.2919 5.4274 6.8485 8.6231 10. 835 19.003 32.919 95.396 264.70

30 2.0976 3.2434 4.3219 5.7435 7.6123 10.063 13.268 17.449 34.243 66.212 237.38
35 2.3732 3.9461 5.5160 7.6861 10.677 14.785 20.414 28.102 61.708 133.18
40 2.6851 4.8010 7.0400 10.286 14.974 21.725 31.409 45.259 111.20
45 3.0379 5.8412 8.9850 13.765 21.002 31.920 48.327 72.890
50 3.4371 7.1067 11.467 18.420 29.457 46.902 74.358 117.39

Table B v Table C- snl Sum or Table D-Lnn

Present Value of 1 Amount of Annuity of 1 Present Value of Annuity of 1
n (1+ )n = 1 = (1+i)_ -1 oR = 1- (+i)

n 57. 6% 77. 87. 5% 6% 7% 8% 5%7 6% 7% 87

5 .7835 .7473 .7130 .6806 5.526 5.637 5.751 5.867 4.329 4.212 4.100 3.993
6 .7462 .7050 .6663 .6302 6. 802 6.975 7.153 7.336 5.076 4.917 4.767 4.623
7 .7107 .6651 .6227 .5835 8.142 8.394 8.654 8.923 5.786 5.582 5.389 5.206
8 .6768 .6274 .5820 .5403 9.549 9.897 10.26 10.64 6.463 6.210 5.971 5.747
9 .6446 .5919 .5439 .5002 11.03 11.49 11.98 12.49 7.108 6.802 6.515 6.247

10 .6139 .5584 .5083 .4632 12.58 13.18 13.82 14.49 7.722 7.360 7.024 6.710
11 .5847 .5268 .4751 .4289 14.21 14.97 15.78 16.65 8.306 7.887 7.499 7.139
12 . 5568 .4970 .4440 .3971 15.92 16.87 17. 89 18.98 8.863 8.384 7.943 7. 536
15 .4810 .4173 .3624 .3152 21.58 23.20 25. 13 27. 15 10.38 9. 712 9.108 8.559
20 . 3769 . 3118 . 2584 . 2145 33.07 36. 79 41. 00 45. 76 12.46 11. 47 10. 59 9. 818
25 .2953 .2330 .1842 .1460 47.73 54.86 63.25 73.11 14.09 12.78 11.65 10.67

M!AY-JUNE 1964 113

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at the beginning of each interval. These special cases (23.28) is $11,640, the approximate amount available
are covered in standard textbooks. in 15 years. (b) Using the same factor from Table C,
An illustration will clarify the nature of the amount again consider that for each $1.00 set aside at the end
(or sum) of an annuity (Table C): of each year there will be a final value (at a 6% return)
AmountAdded Total Addition
of $23.28. Dividing the desired final sum of $15,000
to Fundat InterestEarned to Fundfor Valueof Fund by 23.28, we find that the annual requirement is about
Endof Year on Total Fund the Year at Endof Year
$644. This can also be derived from (a), as follows:
1st year $10,000 None $10,000 $10,000
2nd year 10,000 $ 500 10,500 20,500 15,000 x
3rd year 10,000 1,025 11,025 31,525 and X = $644
4th year 10,000 1,576 11,576 43,101 11,640 500
5th year 10,000 2,155 12,155 55,256
(c) Use Tables A and C. The initial $5,000 will be-
In Table C note the amount of an annuity (value on come $5,000(2.7590), or $13,795. This leaves $11,205
terminal date) of $1.00 per year for five years at 5%; of the desired $25,000 to be obtained from annual addi-
this is $5.526. For $10,000 the amount is $55,260 (to tion of new funds. Dividing $11,205 by 23.28 gives the
four significant figures). This is the same as the value required annual amount of about $481.
obtained in the above table, with the $4 discrepancy due
to rounding. EXAMPLE 10. Mrs. Berg, age 65, has received
We may arrive at the same value by following the $100,000 from her husband's life insurance. She states
process suggested by our definition of the sum of an that she needs $8,000 per year to maintain her accus-
annuity; note that the final column of the following table tomed standard of living. (a) How long will her capital
is the inverse of the next to last column of the preceding last if she spends $8,000 per year, assuming an average
table. return of 6% (including appreciation of equities and
net of costs)? (b) Assuming a 6% return, how much
PeriodFromEach$10,000 Compound Amount Valueof Payment
Paymentto Final Date of 1 (TableA) at Final Date can she spend each year from income and principal, if
4 years 1.2155 $12,155 capital will not be exhausted for 35 years, or before
3 years 1.1576 11,576 age 100?
2 years 1.1025 11,025 Solution. (a) Divide $100,000 present value by the
1 year 1.0500 10,500
None (paid on final date) (1.0000) 10,000 $8,000 desired annuity; the quotient is 12.5. Under 6%
in Table D we find that 12.5 falls between 11.47 (for
$55,256 20 years) and 12.78 (for 25 years). We estimate that at
The direct relation between the amount and the a 6% net return Mrs. Berg's capital would be exhausted
present value of an annuity is given by the compound in about 24 years, or at age 89. Unusual longevity, a
amount or discount (Table A or B). Thus, the amount lower return, unfavorable market developments, or poor
(terminal value) $55,256 in the above example has a investment management would jeopardize her future
present value, discounted at 5%, of $55,256(.7835), security. (b) Our condensed Table D does not cover
or $43,293. Using Table D to obtain this directly, we 35 years. If detailed annuity tables are not available, we
find that the present value of an annuity of 1 for five may use Table A by substituting the compound amount
years at 5% is $4.329; for an annuity of $10,000 per factor in the formula for the present value of an annuity
year, this would be about $43,290, the same figure (see Table D). First, recall that 1.06-'s means 1/1.06n.
except for rounding. Table A shows that the compound amount of $1.00 at
6% for 35 years is $7.6861. Using a slide rule or calcu-
Upon reflection you will recognize that by definition
lator, we find that 1/7.6861 is about .13; 1 minus .13 is
Table D is the product of Tables B and C, or is Table C
.87; .87 divided by .06 is about 14.5. Dividing $100,000
divided by Table A. You will perceive this relationship
in the formulas shown with each table. by 14.5 we find that Mrs. Berg could spend about
$6,900 per year.
EXAMPLE9. A client is planning an educational fund
for his children. Income will be reinvested. (a) If $500 Approximation Without Tables
new money is added to the fund each year, how much In conferring with clients the investment advisor will
will be available in 15 years, assuming a 6% return? occasionally wish to make rough annuity estimates with-
(b) How much must be set aside annually at 6% to out tables. (We would observe that precise mathematical
accumulate $15,000 in 15 years? (c) If he can place calculations have no special merit in making such future
$5,000 in the fund at this time, how much must be set projections, especially where equity investments are
aside annually to accumulate $25,000 in 15 years? In concerned.) Using Mrs. Berg as an example, note that
the latter case, assume a return of 7 % on the initial her fund will be $50,000 when one-half exhausted. The
sum but only 6% on the annual additions and on re- average return at 6% on average capital of $50,000 is
invested income from the annuity portion. $3,000; this leaves $5,000 of the $8,000 annual require-
Solution. (a) In Table C, note that the amount ment in (a) to be obtained from principal. On this basis
(accumulated final value) of an annuity of $1.00 at the the $100,000 fund would last about 20 years. Our
end of each year for 15 years at 6% is $23.28; $500 previous calculation indicated about 24 years. In (b)

114 FINANCIAL ANALYSTS JOURNAL.

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we assumed exhaustionof capital in 35 years. Mrs. cisions involve implicitassumptionswith respectto the
Berg could spend annually 1/35 of her initial capital long as well as the short term future. The analyst's
plus $3,000 averageincome;this is about $2,857 plus judgmentis sharpenedby the effort of expressinghis
$3,000 or $5,857 per year. Our computedamountwas conceptof a company'sprospectsin quantitativeterms.
about $6,900. Such approximationswill vary in reli- We will firstshow how the total of a growingseries can
ability,dependingon the rate of returnand time period. be readilyprojected. We will then use this tool in one
Mathematically,the average investment is actually of our approachesto comparativeequityvaluation.
greaterthan half the initial principal,and the average Refer now to the five-year illustrativetable at the
principalencroachmentto provide a given annual re- beginningof our discussionof annuitiesand Tables C
quirementis less than that derived by approximation and D. The next to the last column ($10,000 to
withouttables. $12,155) is a typical series growingat a constantrate,
EXAMPLE 11. Your advice is sought in connection in this instance at 5% per year. Note that the final
with a propertysettlementfor Mrs. Gray. Settlement column ($10,000 to $55,256) is the cumulativetotal of
will be cash and will be invested in bonds and stocks. the entriesin the precedingcolumn down to any year.
All parties agree to assumea 5% return,includingin- In terms of an annuityof 1, the amountof an annuity
come and appreciationand net of costs. Mrs. Gray is at 5% for five periodsis 5.526; this is also the total of
to receive $5,000 per year for 25 years. After 25 years a seriesof five annualpaymentsbeginningat $1.00 and
(or on Mrs. Gray'sdeath, if earlier), any balance will growingat 5% compoundedper year. Thus, the table
revertto the settloror his heirs. (a) What initial fund or formulafor the amount of an annuity (see top of
is required? (b) On the assumptions,how much would Table C) may be used to determinethe total of a series
remainat the end of 10 years? (c) Discountingat 5%, (such as earningsor dividends) growingat annualrate
whatis the presentvalueof the amountwhichwill revert i for n years.
to the settlor if Mrs. Gray lives just 10 years? In this EXAMPLE 12. If a company's current dividend is
case, what is the net cost to the settlor? $4.00 per shareand a growthrate of 7% is anticipated
Solution. (a) Table D gives $14.09 as the present for a decadeor more,what are projectedtotal dividends
value of an annuity of $ 1.00 at 5 % for 25 years. for the next 10 years?
The requiredinitial fund is $5,000(14.09), or about Solution. Table C gives 13.82 as the amount (sum)
$70,450. (If precisionis desired,tablesto more decimal of an annuityof 1 at 7% for 10 years. Total projected
places should be used.) (b) The projectedremaining dividendsfor 10 years are $4.00(13.82), or $55.28.
fund after 10 years can be developedin several ways.
(1) We may use Table A to project the value of EXAMPLE 13. Present dividend rate is $5.00; as-
$70,450 at 5% in 10 years; then use Table C to de- sumed growthrate is 4%. Project total dividendsfor
terminethe amountof an annuityof $5,000 at 5% for the next five years.
10 years; subtractingwe find the estimatedremaining Solution. Our condensed Table C does not show
fund to be about $51,856. (2) Alternatively,we may 4%; derivethe requiredfactorfrom Table A, using the
subtractthe present value of an annuityof $5,000 at formulashown with Table C. Note that the compound
5% for 10 years (Table D) from the initial amountof amountof 1 at 4% for five years is 1.2167; subtract1
$70,450; then use Table A to projectthis value for 10 and divideby .04; the amountof annuityfactoris about
years. With our condensedtables we get a projected 5.42. Total dividendsare projectedat $5.00(5.42), or
value of $51,864, with the slight difference due to about $27.
rounding. (c) We have found that the value of the
Comparative Equity Valuation
fund remainingin 10 years will be about $51,860; dis-
counted at 5% to its present value we have $51,860- The valueof a commonstock reflectspast and current
(.6139), or about $31,837. Thus, the net cost to the earningsand dividends,qualityand other characteristics
settlor if Mrs. Gray lives just 10 years is $70,450 less as identified from the past record, and, particularly,
$31,837, or about $38,613. futureprospects. Estimatesof future prospectsusually
reflectthe past recordto a considerabledegree,but the
Estimating the Total of a Growing analystmust also considermany factorsnot susceptible
Series of Earnings or Dividends of measurementand requiringthe exerciseof judgment.
We now considerthe problemof estimatingthe total Because the subjective element is substantial, many
of a series of periodic figures growing at an assumed analysts prefer not to attempt to evaluate equities in
constantrate. A typical exampleis annualearningsor quantitativeterms. As we have stated, our position is
dividends per share. Projection of total earnings or that projections(not forecasts) on a quantitativebasis
dividendsfor a period of years is often useful in con- are implicitin investmentdecisions and that the effort
sideringthe relativeattractionof alternativeinvestments. to formulatespecificprojectionsof future earningsand
Many analystsfeel that it is difficultenough to pre- dividendsas a basis for comparativevaluationwill, on
dict earningssix monthsin the future,let alone five or the whole, lead to morereliablejudgments.
ten years. In our view a distinctionshould be made We will use the following table as the basis for an
between a predictionand a projection. Investmentde- introductorydiscussionof comparativeequityvaluation.

MAY-JUNE 1964 115

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In including the Dow-Jones Industrial Average our pur- subjectivemanner,the analyst is alerted to review his
pose is illustrative; we intend no implication with respect thinkingwith care.
to its current value.
The Price-Future Earnings Ratio
Dow-Jones Stock Stock Stock Stock Stock
Industrials No. 1 No. 2 No. 3 No. 4 No. 5 The price-futureearningsratio is simply the payout
Market price 800 60 63 72 87 114 period,or the numberof years requiredto amortizethe
Current earn. 44 3.00 3.00 3.00 3.00 3.00 market price out of the flow of rising earnings. The
Dividend rate 24 2.40 2.00 1.60 1.40 1.00 writer discussed this approachin some detail in the
Payout 55% 80% 670/c 53% 47%l 33%o
P/E ratio 18.2 20 21 24 29 38 August 1958 issue of The FinancialAnalysts Journal.
Yield 3.0%l 4.0%cc 3.2/cl 2.2% 1.6% .9% We presentbelow a portionof the table includedin that
Proj. growth 4%cl 4 1/4 5cC, 7%T 9% 121/2% article. Fromthe discussionprecedingour examples12
and 13 the derivationof the table from the formulafor
EXAMPLE 14. Our first approach to valuation illus- the amountof an annuityis evident.
trates a conservative and widely used technique: the
current market is related to projected earnings in five
Using the annuityformula,if x is the price-earnings
ratio, n the price-futureearningsratio, and i the as-
years. The compound amount factor for each assumed
growth rate is applied to current earnings. If earnings
sumed constant annual rate of growthof earningsper
are abnormally high or low for temporary or non-recur-
share,then
ring reasons, they may be adjusted as a basis for pro- (1 + i)n-1 log (ix + 1)
jection. Since the remaining examples are all based on x= and n=
the above tabulation, we omit column headings. i log (1 + i)

Proj. earnings in 5 yrs. 531/2 3.65 3.83 4.21 4.62 5.41 Price-future earnings ratio
Market/projected earn. 15.0 16.4 16.4 17.1 18.8 21.1 Price-
earnings Estimated annual growth of earnings
Whereas the six price-earnings ratios based on cur- ratio 3%clo 5 % 7 % 10 % 12 %/G 15 % 20%/o
rent earnings range from 18.2 to 38, the ratios to pro- 12 10.4 9.6 9.0 8.3 7.9 7.4 6.7
jected earnings in five years fall in the considerably 14 11.9 10.9 10.1 9.2 8.7 8.1 7.3
narrower range of 15.0 to 21.1. However, in all but one 16 13.3 12.0 11.1 10.0 9.5 8.8 7.9
case the higher ratios are still associated with superior 18 14.6 13.2 12.1 10.8 10.2 9.4 8.4
20 15.9 14.2 12.9 11.5 10.8 9.9 8.8
growth prospects. Obviously the market places a greater
premium on superior growth than that implied by the 22 17.1 15.2 13.8 12.2 11.4 10.4 9.2
ratio of price to earnings in five years (our hypothetical 24 18.3 16.2 14.6 12.8 12.0 10.9 9.6
26 19.5 17.1 15.3 13.4 12.5 11.4 10.0
stocks are fairly typical of present market conditions). 28 17.9 16.0 14.0 13.0 11.8 10.4
Nonetheless, value comparisons are facilitated, and the 30 18.8 16.7 14.5 13.5 12.2 10.7
approach has the advantage of encouraging very con- 32 19.6 17.4 15.1 13.9 12.6 11.0
servative premiums for superior future expectations, at 34 18.0 15.5 14.3 12.9 11.3
best uncertain. However, when growth projections are 36 18.6 16.0 14.7 13.3 11.5
well founded and made with caution, we consider pro- 40 19.7 16.9 15.5 13.9 12.1
jected earnings in five years an unnecessarily conserva- 50 18.8 17.2 15.3 13.2
75 22.5 20.3 17.9 15.2
tive basis for the comparison of values.
EXAMPLE 15. We may use the same approach with EXAMPLE 16. Applying the price-futureearnings
earnings projected seven years instead of five. The ratio to our examples,we have:
longer projection, of course, places greater importance P/E ratio 18.2 20 21 24 29 38
on the reliability of our growth estimates. Growth rate 4% 4% 5% 7% 9% 121/2%
Proj. earnings in 7 yrs. 58 3.95 4.22 4.82 P/FE ratio 14 15 143/4 14'/2 15 15
5.48 6.84
Market/projected earn. 13.8 15.2 14.9 14.9 15.9 16.7 Except for very high growth rates, the price-future
The ratios of market to projected earnings now fall in earningsratiosuggestsconclusionsquite similarto those
the much narrower range 13.8 to 16.7. The relation of reachedby relatingthe priceto earningsprojectedseven
prices to earnings prospects is more adequately mea- years. Note, however,that a P/FE of 15 tendsto imply
sured, at least in terms of the valuations characteristic that earningsgrowthwill continue at the assumedrate
of the present market. Computations such as these are for 15 years. The approachcan be quite misleadingif
rarely if ever conclusive evidence that one stock is a the growth projectionis too high. It is often wise to
better value than another. Quantitative estimates or scale down a very high recentgrowthrate. Perhapsthe
measures of value are tools to be used in conjunction greatestadvantageof this approachis its convenience:
with many other considerations, such as investment one merely inspects a table to determinethe payout
quality and standing, the confidence in the projection, periodor P/FE associatedwith the currentmultipleand
evaluation of changes in a company's operations and the assumedrate of growth. (Copies of a more detailed
prospects, et cetera. In general, however, such consid- P/FE tablemay be obtainedfromthe authoron request.
erations can be given quantitative expression. If the Some reprintsof the August 1958 articleare available.)
results do not support conclusions reached in a more The price-futureearningsratio and the ratio of cur-
116 FINANCIAL ANALYSTS JOURNAL

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rent market to projected earnings in five or seven years ing techniques will be developed. While not new or
share one disadvantage: the dividend factor is ignored. original, such approaches are still unfamiliar to many
Payout, quality, confidence in future projections and analysts. We will introduce some modifications which
similar considerations can be taken into account through may be of interest.
modification of the growth rate, but this expedient is It is doubtless evident that mathematical approaches
somewhat awkward and imprecise. Nonetheless, when can by no means resolve all the problems of equity
used with discrimination these approaches have proved valuation. Their greatest value may lie in providing a
to be effective as well as simple. means of analyzing the implications of a given level of
In the article on equity valuation in preparation a stock prices and of identifying specific instances of over-
somewhat more sophisticated approach using discount- valuation and undervaluation more clearly. *

QUARTERLYDIVIDENDS SINCE 1935

NATIONAL
DISTI
LLERS
........... ~and
CHEMICAL
CORPORATION
DIVIDEND NOT/CE
The Board of Directors has declared a
quarterly dividend of 30? per share on
the outstanding Common Stock, pay-
able on June 1, 1964, to stockholders
of record on May 11, 1964. The transfer

ACE : KA O E How
It Worksin theUtilityField | April 23, 1964.
RAMSEY E. JOSLIN, Treasurer

AVERAGEPRICEOF RESIDENTIAL
ELECTRICITY
(DOWN)
UNITED STATES CALlFORNIA-PACIFIC UTILITIESCO.

4 __

1943 1963 1943 1963

It.J. iteynioIds
3.60% 2.37% 4.100 1.71% *
PER KWH PER KWH PER KWH PER KWH

AVERAGEUSE IN ELECTRIFIED
HOMES(UP)
UNITEDSTATES CALIFORNIA-PACIFICUTILITIES CO. ToUbacaao any
CIoAImpI
8
61
Makers of I
4 ~~~~~~~~~~~~~~Camel,
Winston,Salem&Cavalier
| _ 2 _ I I cigarettes
_ _ O _ _ |Prince Albert,GeorgeWashington
|
000
1943 1963 OF KWH 1943 1963 IkCarter Hall
1070 4465 1246 7345 i t
KWH KWH KWH KWH

QUARTERLY DIVIDEND
California-PacificUtilities specializes TOTAL NET A quarterly dividend of 45c
in providingsmall cities, villages and R
R EVENUES
ENUES INCOME
INCOME per share has been declared
rural areas with electric, gas, tele- on the Common Stock of the
phone, and other services. Catering 1943 $ 913,000 $ 133,000 Company, payable June 5,
to grass roots country, selling the 1964 to stockholders of record
big economy-size package at budget- 1953 7,111,000 595,000 at the close of business May
easy prices, has made the company 1963 14,515,000 1,275,000 15, 1964.
a real "growth situation ... To wit: ___*_I_I_
I WILLIAM R. LYBROOK,
Vice Presidentand Secretary
Winston-Salem N. C.
| @ / CALIFORNIA-PACIFIC
UTILITIES
COMPANY April 10 1964
550 CALIFORNIA STREET * SAN FRANCISCO, CALIFORNIA Sixty-four Consecutive Years of
Cash Dividend Payments

MAY-JUNE 1964 117

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