What Drives Growth: Analyzing Quantitative Factors and their Variation across Sectors

Abstract

Value investing is often considered the antithesis of growth investing. However, core to any value investing strategy is an intrinsic valuation, typically calculated using a DCF analysis. One of the most sensitive DCF assumptions is the estimation of a company’s long-term cash flow growth rate. Thus, understanding a company’s growth potential is a vital component in any value thesis. This paper attempts to create a quantitative model to help predict a company’s long-term cash flow growth rate (using EBITDA growth as a proxy for cash flow growth) and to find the strongest indicators for a company’s growth potential by sector. To do so, this study analyzes variables pertaining to operating efficiency, risk metrics, market valuation, corporate investment levels, and the competitive landscape for S&P 500 constituent companies. While all categories contributed at least one statistically significant variable, the market valuation and corporate investment level categories had the highest volume of significant variables. The results show that widely used quantitative metrics can help predict a meaningful portion of a company’s five-year EBITDA growth rate when analyzed on a sector-by-sector basis. Furthermore, both the types of variables and predictive strength of the model varies widely across sectors. In practice, analysts should prioritize different ratios, metrics, and quantitative variables based on the target company’s sector when estimating the trajectory of a company’s long-term growth rate.