Duration of Competitive Advantage, Cash Flow Period, and Residual Value

This research presents a methodology to estimate the duration of the competitive advantage period (CAP) for companies based on the duration implied in market prices. The CAP is defined as the period during which a company can continue to grow by finding new investment opportunities where the return exceeds the cost of equity. This study applies the methodology to the Standard and Poor’s 500, finding that the average CAP is twenty-one years when assuming that excess returns or competitive advantages gradually extinguish in the years following this period. If we assume that companies maintain their competitive advantage indefinitely for investments made during the CAP, the duration reduces to seventeen years. Additionally, the study provides guidance on the appropriate residual value formula to use based on the CAP and the assumptions regarding the duration of competitive advantage.