Avoid assumptions about extrapolated growth in future earnings
Assumptions about growth in future earnings extrapolated from current or past earnings are unreliable for a valuation exercise.
Also suspect for pure value investors are assumptions about growth in future earnings extrapolated from current or past earnings.
Unlike extreme devotees of growth investing, value investors consider current earnings – adjusted as described – to be the best estimate of sustainable future cash flows.
A key reason to deny estimated and unknown earnings growth is that absent sustainable competitive advantages or barriers to competitor entry, growth lacks value.
If new entrants can join a company’s industry as equal competitors, the effect drives a company’s returns to just equal their costs – no upside is sustainable so growth adds nothing.
Growing a business measured in sales requires growing the business measured in assets. Growing assets requires capital, which also poses a cost. Facing competitive entrants, the process goes nowhere (except remotely due to luck and temporarily – benefits value investors do not pay for).
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