likelihoodthatthevaluewillbelower.Forinstance,astock
withanexpectedvalueof$40isagoodbuyifthestockprice
is$30,evenifthereisa 40 percentchancethatthevaluewill
be less than $30.
CONCLUSION
Forecastingfuturecashflowsiskeytovaluingbusinesses.In
makingtheseestimates,wecanrelyonthepasthistoryofthe
firmoronestimatessuppliedtousbyanalystsormanagers,
but we do so at our own risk. Past growth rates are not
reliableforecastersoffuturegrowth,andmanagement/analyst
estimatesofgrowthareoftenbiased.Tyingexpectedgrowth
totheinvestmentpolicyofthefirm—howmuchitreinvests
andhowwellitchoosesitsinvestments—notonlyisprudent
but also preserves internal consistency in valuations.
Whenvaluingequity,especially inhigh-growth businesses,
thebulkofthevaluewillcomefromtheterminalvalue.To
keepterminalvaluesboundedandreasonable,thegrowthrate
usedinperpetuityshouldbelessthanorequaltothegrowth
rateoftheeconomy,andthereinvestmentrateassumedhasto
be consistent with the growth rate.
1 Growthwithoutexcessreturnswillmakeafirmlargerbut
not more valuable.
2 Jack Welch atGeneralElectric and RobertoGoizueta at
Coca-Cola were good examples of CEOs who made a
profounddifferenceinthegrowthoftheirfirms,whichwere
perceived as mature firms when they took the reins.