Damodaran on Valuation

4.3. DETAILED CASH FLOW FORECASTS

Once the length of the extraordinary growth period has been established, we have to forecast cash flows over that period. It is in this stage of the process that we will be called upon to make our best judgments on how the company being valued will evolve over the coming years. We begin this section by looking at the most logical source for these estimates, which is the company's own past, but pinpoint some dangers associated with relying on history. We also consider using estimates for the future provided by those we view as more in the know, which would include the company's management and analysts tracking the company. We close the section by presenting the link between growth and a company's fundamentals.

4.3.1. Past as Prologue

When estimating the expected growth for a firm, we generally begin by looking at the firm's history. How rapidly have the firm's operations, as measured by revenues or earnings, grown in the recent past? While past growth is not always a good indicator of future growth, it does convey information that can be valuable while making estimates for the future. In this subsection, we begin by looking at measurement issues that arise when estimating past growth and then consider how past growth can be used in projections.

4.3.1.1. Estimating Historical Growth

Given a firm's earnings history, estimating historical growth rates may seem like a simple exercise. But there are several measurement problems that may arise. In ...