Key insights
- This opinion piece argues that extreme valuations, often seen in companies like Nvidia or Tesla, may not be irrational but rather reflect buyers accepting very low future returns due to factors like scarcity or status. The author posits that a low discount rate can justify high valuations, even if forward returns are poor. This perspective is extended to value investing, suggesting that reliance on optimistic assumptions within DCF models can also mask similar issues. The core argument is that 'awful forward return' is distinct from 'irrational valuation'.
People often look at companies like SpaceX, OpenAI, Nvidia, Tesla, etc. and say something like: “This valuation makes no sense. The market has gone insane.”
I’m not sure that’s actually the right conclusion.
A valuation can look absurd without the math being absurd. It may simply mean that the buyer is using, whether explicitly or not, a very low discount rate.
Take the basic perpetuity formula:
Value = Cash Flow / Discount Rate
Or:
PV = CF / r
Now take a silly example.
Suppose an asset will eventually generate $0.01 of free cash flow every year forever.
At a 10% discount rate:
$0.01 / 0.10 = $0.10
At a 1% discount rate:
$0.01 / 0.01 = $1.00
At a 0.1% discount rate:
$0.01 / 0.001 = $10.00
At a 0.01% discount rate:
$0.01 / 0.0001 = $100.00
And so on.
Push the required return low enough, and even a tiny perpetual cash flow can justify a huge valuation.
So when people say, “There is no way this company is worth X,” I think the hidden question is:
Worth X to whom, and at what required return?
If the marginal buyer is willing to accept a 2%, 1%, or almost zero expected return because they want access, scarcity, optionality, status, indexing exposure, or simply exposure to a one-of-one asset, then the valuation can look insane while still being internally consistent.
That does not mean it is a good investment. It may actually mean the forward return is awful.
But “awful forward return” is not the same thing as “irrational valuation.”
And I think this also applies to value investing.
A lot of value investors talk as if this problem only exists in growth investing. I don’t think that’s true.
If your DCF depends heavily on:
- a very low discount rate, * a huge terminal value, * a moat lasting longer than expected, * normalized margins that may never come back, * or a business surviving indefinitely,
then you are also making a big claim about the future. It just looks more respectable because it’s inside a spreadsheet.
So maybe the real divide is not value vs. growth.
Maybe the real divide is:
What return are you actually underwriting?
My view is that many “crazy” valuations are not necessarily proof that the market has lost its mind. They may just be proof that the marginal buyer is willing to accept a much lower future return than the critics are willing to accept.
CMV.