Bruce Greenwald: Why It’s So Difficult To Value Companies

In this interview with MOI Global, Bruce Greenwald discusses why it’s so difficulty to value companies. Here’s an excerpt from the interview:

Greenwald: Let’s talk a little about how you value growth because that’ll give you a feel for how hard it is and how important it will be to know that business and be specialized. If you think of a growing firm and buying a growing firm, most of the value is way out there in the future.

Typically, when you do a DCF on a growth stock, you’ll do five years of cash flow projections, and then you’ll do a terminal value. Somewhere above 80% of all the value will be in the terminal value.

The terminal value will be a terminal cash flow times a multiple, and the multiple is one over the difference between the growth rate in that terminal cash flow and the cost of capital.

If the growth rate is four and the cost of capital is eight, 4% is the difference. The multiple will be one over four percent or 25%. But suppose you’re off by 1% in either of those numbers.

Suppose the growth rate is not 4%, it’s 3% instead. The cost of capital is not 8%, it’s 9% minus 3%, 6%. One over six percent is 16x, not 25x. On the flip side of that, suppose the growth rate is 5% and the cost of capital is 7% and these are 1% errors in projecting a long-term future. Seven minus five is 2%.

One over two percent is a 50x multiple. Within a narrow range of forecasted growth rates and what future risks might look like, you can get a 3:1 variation in multiples. You had better be an expert if you play that game.

You can read the entire interview here:

Bruce Greenwald Interview – MOI Global