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Technology Stocks : All About Sun Microsystems
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To: Walter in HK who wrote (16445)5/17/1999 11:04:00 PM
From: Feathered Propeller  Read Replies (2) of 64865
 
WalterinHK: Re present value of future earnings.

FWIW:My observation is that Investor2 is correct in saying that your logic is correct, but Alok is correct is saying that your discount rate must account for risk.

The discount rate which equates the value of the future earnings stream with the current price of the stock is the Internal Rate of Return, (IRR). Without checking your math, in your example you have predetermined that rate in order to see what price you would pay, (131x $1= $131).

Try thinking of it this way:

Why would you pay that price for a future stream of earnings at a rate of return that you could achieve by merely investing in 30 year treasuries?

Since the uncertainty of the company's earnings are far greater than that of the US Treasury, would you not want to apply a greater discount to the stream to account for that risk. Or, in essence, how much of a return would you want for the extra risk, a 15% return, a 20% return??

If you use the logic of the risk adjusted discount rate in your IRR calculation, it seems to me you will feel far less comfortable with the current valuation... without assuming even greater growth rates.

But... if everyone had the same perception of that risk and growth... there wouldn't be a marketplace!!

Good investing.

JCC

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