Competitive advantage period (CAP) — Part 3

By: Level13

The CAP for the U.S. stock market, as a whole, is estimated to be between 10 and15 years. However, within that aggregate, individual company CAPs can vary from 0-2 years to over 20 years. As a general rule, companies with low multiples tend to have shorter CAPs. Alternatively, companies with high multiples typically have long CAPs.

For example, companies like Microsoft and Coca-Cola have CAPs well in excess of 20 years, demonstrating their perceived market dominance, the sustainability of high returns, and the market’s willingness to take the long view. If a substantial percentage of the value of a company can be attributed to cash flows beyond a few years, it is difficult to argue persuasively that the market is short-term-oriented. In turn, it follows that the forecast periods used in most valuation models are not long enough.

It may be more important for the investor to try to quantify CAP than to pass judgment on its correctness. As noted earlier, the components of value are all expectational, and therefore must be considered relative to one another and against the expectations for the business overall. There are a number of ways of estimating CAP, but one of the most useful methods was developed by Al Rappaport. The technique is known as market-implied CAP (MICAP). Determination of the MICAP has a few steps.
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Competitive advantage period (CAP) — Part 1
Competitive advantage period (CAP) — Part 2

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