What is the value of the following earnings streams?

[spartansaver]

Both businesses grow in-line with GDP - assume Invested Capital is $100. 

 

Business A averages a 10% ROIC and earns that every year without fail.

 

Business B averages a 10% ROIC but earns -10% some years and +30% other years.

 

What are these two earnings streams worth?

 

[ValueArb]

The intrinsic value is dependent upon some missing information

 

1) your risk free return rate, so without that can't do a DCF. 

2) Are earnings dividended out or re-invested at the same ROIC?

 

Valuing them relatively is pretty easy. Assuming you pay book value, and all earnings are retained by the business (tax free) in 20 years Business A reaches a book value of $672, while Business B (assuming alternating +30% and -10% years) reaches a book value of somewhere in the $470-$480 range. Plus Business A's consistent performance is evidence of a strong moat, while Business B's performance is evidence of a weak moat, or very cyclical industry.

 

Now that was unfair to Business B, because alternating -10% and +30% years produces a 17% gain over those years instead of the 21% two +10% years produce. So in reality we need to alternate -10% and +34.44% years to get equal returns over alternating years. But even in that case I think you give Business A a higher relative value because moat and consistency mean future returns are more trustworthy.

[jks327]

Business B sounds like a lot of companies in the aviation industry.  I asked basically the same question the other day to a successful investor I know and he told me to throw away the rearview mirror