Capitalized Earnings Method
Capitalization converts a single year of representative earnings into value in one step. Its honesty rests entirely on two judgments: whether the earnings figure is truly representative, and whether the rate reflects the real risk of this company rather than a rule of thumb. ExitSight builds the rate up from its components so both are visible to a reviewer.
THE FORMULA
Value = Stabilized earnings ÷ Capitalization rate
Capitalization rate = discount rate − long-term sustainable growth rate.
When to use it
- Earnings have been stable for three to five years with no step change expected.
- Growth is modest and steady rather than lumpy.
- Professional management is in place and compensation is at market.
- You need a cross-check on a discounted cash flow conclusion.
When it misleads
- A major contract, expansion, or loss will change the earnings base.
- The company is in a turnaround or has just changed its business model.
- Growth is close to the discount rate, which drives the capitalization rate toward zero and the value toward infinity.
What ExitSight asks you for
| Input | Where it comes from |
|---|---|
| Stabilized net earnings | Recast statements; weighted or simple average of recent years |
| Discount rate build-up | Risk-free rate, equity risk premium, size premium, company-specific risk |
| Sustainable growth rate | Your estimate; capped below the discount rate |
| Entity type and tax rate | Company profile; controls whether earnings are pre- or post-entity tax |
| Non-operating assets and debt | Balance sheet worksheet |
Worked example
The sample engagement, capitalizing next year’s expected earnings:
| Business earnings (EBITDA) | $135,910 |
| Long-term growth rate | 4% |
| Discount rate | 20% |
| Capitalization rate | 16.0% |
| Next-year earnings (× 1.04) | $141,346 |
| Indicated value | $883,415 |
In the report
Prints as Table 6 with the discount rate build-up shown line by line and the growth assumption stated in the narrative. See the sample report ›