Terminal Value Dominance and the Fragility of Equity Valuations

Discounted cash flow valuation is widely regarded as the most theoretically coherent framework for estimating intrinsic value, yet in practice it is structurally dominated by terminal assumptions that are weakly constrained by observable data. Because firms are long-lived and explicit forecast horizons are necessarily finite, a substantial proportion of estimated value is embedded in assumptions about distant future cash flows, long-run growth, and discount rates (Damodaran, 2012). Empirical evidence shows that terminal value frequently accounts for the majority of enterprise value in equity DCF models, rendering intrinsic value estimates highly sensitive to small changes in parameters that are difficult to validate (Behr, 2018). This sensitivity is transmitted into market pricing through equity duration, such that firms whose value is concentrated in distant cash flows exhibit heightened exposure to changes in discount rates and macroeconomic regimes, even in the absence of revisions to near-term fundamentals (Dechow, Sloan and Soliman, 2004). Behavioural anchoring further reinforces reliance on fragile terminal assumptions, contributing to false precision in valuation outputs (Tversky and Kahneman, 1974). Taken together, these dynamics imply that discounted cash flow analysis is most appropriately interpreted as a framework for understanding sensitivity, duration, and regime dependence, rather than as a tool for producing precise intrinsic value estimates (Penman, 2018).