FREE CASH FLOWS, VALUATION AND GROWTH OPPORTUNITIES BIAS

Hersh Shefrin

Analysts who base valuations on expected free cash flows are vulnerable to making biased assessments of terminal value because they fail to take into account the implications of disappearing growth opportunities during the terminal period. This leaves their valuations subject to “growth opportunities bias” (GOB). There are two sets of issues addressed in this paper, one narrow and the other broad. The narrow issues pertain to the basis for GOB, a technique for addressing it, and examples to illustrate the debiasing technique. The broader issues pertain to group psychology in respect to the manifestation of GOB in the analyst community, including the CFA Institute which certifies analysts.