I am increasingly bothered by the fact that many of my five-year financial forecasts for going concern operating businesses bear a striking similarity: in the latter forecast years, cash in the business builds up significantly. Usually this results from the assumption of sustained growth and stable profit margins and normal debt levels. These assumptions are usual, customary and reasonable based on the economic outlook, industry and company analysis and the facts of the situation. There’s just one little problem:
I can’t recall ever valuing a business that historically piled up cash year after year!
When my experience contradicts my logic, that usually means that I have made a bad assumption somewhere. The problem in this case is that the bad assumption is not at all obvious. Perhaps:
1. Growth will require capital expenditures that I have not factored in.
2. Sustained growth and margins may not be achievable due to market size or share constraints or competitive pressures.
3. Growth may outstrip current management’s ability to plan for and to control it.
4. I have not factored in contingency expenses (reserves for the “known unknown”) that happen to most businesses in most years.
5. It is something else…it could be just about anything…
Have you encountered a similar phenomenon?