Excess returns can be viewed in many ways. In a DCF valuation context, excess returns are returns above the cost of capital. This article explores when a firm can earn excess returns. This page also discusses the conditions required to maintain excess returns.
Why is this important in your DCF context? This is important in a DCF context as you have to make assumptions about growth and returns in your valuation model.
It is possible to earn excess returns only when a company has a competitive advantage. Further, it is possible for a company to maintain those excess returns on a sustainable basis only when a company has a sustainable competitive advantage – a competitive advantage that cannot be easily copied away by competitors.