Some of you will find the first part of this article basic and a repetition of old lessons learned, but please bear with me because there is a point that, I believe, is worth considering in a new context. From the first days of finance class all the way through to investment bubbles that grow and pop, it is established beyond reasonable doubt that the purest and most effective way to estimate the value of an asset is through discounted cash flow analysis. Even other valuation methods that are more easily and freely used and are standard in discussions – such as multiples of earnings or revenues or some other metric – relate back to discounted cash flow and have their equivalency in this tried and true approach. “Because,” the saying goes, “an asset is only worth the cash that it will generate.” This is true of any asset on some level: a statue sold at auction, or a business like Twitter. These will eventually produce cash, even if remotely up ahead where we can’t see. Sentiment aside, therefore, financial value is the present equivalent of such future proceeds, discounting these for risk and passing time.

Now, future cash takes two forms. There is the kind that is generated by the ongoing operation of a business, and there is the kind that is produced by the future sale of the asset to another party. The statue, in the previous example, will only produce the latter kind, while a normal business, such as [Twitter], will [theoretically] produce both, because eventually its operations will generate profit, and eventually the business will be sold. This last element in discounted cash flow analysis is called the asset’s “terminal” value, which in practice may represent more than half of the total valuation, and usually much more than that.

This “terminal” value is a misnomer. Its suggestion of finality is in actuality anything but. In fact, terminal value is predicated on the notion that, at some point in the future, somebody will conduct a discounted cash flow analysis and determine that the asset, at that point in time, will have a certain value going forward. And since this discounted cash flow method applied at that time will also incorporate a terminal value, by definition based on a hypothetical event even farther out, we see how the exercise implicitly extends onward and upward forever. In other words, terminal value is loosely associated with perpetuity, with infinity, rather than finality, (as long as we are not talking about a depleting asset such as a gold mine or a cup of coffee, which would exceed the scope of our discussion.)

Perpetuity is not an easy concept to accept. On its very surface, perpetuity seems like such an enormous word, covering such a very long time and symbolizing an endless economic model. When an asset that is being valued is a fundamentally repeatable business, such as farming, manufacturing, real estate, and the such, perpetuity can be imagined and the concept could make some sense. Yes, prices may vary with time, but this possibility can be factored in the risk adjustment (i.e. the discount rate) applied to the cash stream of our analysis.

What if, however, we are dealing with assets, with businesses, the economic models of which are prone to change within the foreseeable future, and change into something that nobody can predict? In such situations, what does perpetuity mean? And by extension, how should we consider such assets’ terminal values, which, I repeat, constitute the great majority of discounted cash flow valuation?

According to new statistics, Facebook is becoming a hugely popular news interface alongside RSS feeds such as Google Reader. According to Facebook, its new email and search functionalities will rival those of Google. According to Google, its android phone may displace Apple’s iPhone as the market leader. According to Apple, its iPad tablet will make Amazon’s Kindle obsolete, and will push Apple to the forefront of E-commerce. In all of these situations, can we predict with any precision, ten years from now, which will be the search engine, the consumer electronics company , the media outlet, the retailer? In light of the corporate updates cited, and the fact that ten years ago Google hardly existed, this is not a small question. And perpetuity, once again, is a pretty large word.