The Case for Timeweighted Returns

If we accept the arguments that cash flows measure returns more accurately than earnings, and that the incremental cash flows more precisely estimate returns than total cash flows, we should logically follow up by using discounted cash flows (i.e., time-weighted returns) rather than nominal cash flows for two reasons.

1. Nominal cash flows at different points in time are not comparable, and cannot be aggregated to arrive at returns. Discounted cash flows, on the other hand, convert all cash flows on a project to today's terms and allow us to compute returns more consistently.

2. If the objective in investment analysis is to maximize the value of the business taking the investments, we should be weighting cash flows that occur early more than cash flow that occur later, because investors in the business will also do so.

Lessons From The Intelligent Investor

Lessons From The Intelligent Investor

If you're like a lot of people watching the recession unfold, you have likely started to look at your finances under a microscope. Perhaps you have started saving the annual savings rate by people has started to recover a bit.

Get My Free Ebook

Post a comment