Bruce Greenwald: Investors Should Focus On ‘Return Trajectory’ When Valuing Businesses

Here’s a great presentation with Bruce Greenwald on the 1st Annual Roger Murray Lecture Series, with Tano Santos. During the presentation Greenwald discusses why investors should focus on the return trajectory when valuing a business. Here’s an excerpt from the presentation:

Greenwald: But much more importantly if you think about what you do with a DCF. You estimate near-term cash flows and the value of those cash flows appropriately, by appropriately discounted. Then you have to estimate far distant cash flows. Because that’s an important part of what you’re buying.

The problem with the far distant cash flows is that you have really very large errors when you estimate those because they’re far out in the distant future.

Typically they get buried in the terminal value and the terminal value has these huge errors. Then what you do is you take your value related to the near-term cash flows and your values related to the distant cash flows and you add them together.

When you add bad information to good information the bad information dominates and that’s what you’re doing in a DCF.

But when you look at a return you are actually focusing on a trajectory and you’re projecting that trajectory from today. You’re not looking at changes in that trajectory. The best you’re going to do and typically the way you estimate these returns is assuming that trajectory is unchanging.

Constant growth rate, constant profit rates and so on.

That’s the essence by the way of what you’re doing with the terminal value and in the process of doing that you’re going to focus on what’s there today so you’re going to be focusing inherently on the best information. That’s why you’re much better off from this getting rid of the bad information and concentrating your valuation on the good information. So you know what you’re buying to focus on the return, not the value space.

You can watch the entire presentation here: