Great write-up clearly explaining the process to get to the value of a company. I am just curious why not directly start at FCF value to reduce the number of assumptions and calculations?
From FCF, you can use the growth rate based on the analyst's expectations, the company's guidance, and your research? I feel that should help reduce inputs/assumptions and probably reduce errors.
Discount rate - I like you used 12%. I use 10% in my analysis to match the opportunity cost of investing in the Index.
I used to do that but in my experience FCF is very volatile and susceptible to manipulation. Revenue is hardest metric to manipulate and for operating margin, it is easier to check if the current levels of profit sustainable looking back into 5-10 years and also comparing with the competitors to see if there is an explanation of better operating margin from the rest of the pack.
When it comes to analysts' expectations, I usually take them with a grain of salt. I don't give them much weight, as their assumptions often tend to follow market trends rather than predict them.
Replace the number of years as remaining life with infinity to compensate the removal of future growth and the much lower dividend.
A company which does not distribute dividends, but fork out huge compensation/remuneration package for directors, is a crook, it is suitable for short term speculative gaming, but not a candidate for long term investment.
Basically, if I understand your methodology above, you are just adding a bunch of more assumptions, including some macro-level assumptions, to value a company. I do not think that is unnecessary, making it way more complex for no reason.
There is no logic whatsoever to do all that math to figure out a company's value.
"It is better to be precisely right than absolutely wrong"
Hi Pablo, nice effort! As I mentioned in my other post (https://www.moatmind.com/p/discounted-cash-flow-to-internal-rate-of-return), DCF involves a lot of assumptions. You can compare your approach with mine here—I’ve also shared a link to the Google Sheet in this post above. Feel free to ask if you have any specific questions.
Great write-up clearly explaining the process to get to the value of a company. I am just curious why not directly start at FCF value to reduce the number of assumptions and calculations?
From FCF, you can use the growth rate based on the analyst's expectations, the company's guidance, and your research? I feel that should help reduce inputs/assumptions and probably reduce errors.
Discount rate - I like you used 12%. I use 10% in my analysis to match the opportunity cost of investing in the Index.
Thanks for the feedback!
I used to do that but in my experience FCF is very volatile and susceptible to manipulation. Revenue is hardest metric to manipulate and for operating margin, it is easier to check if the current levels of profit sustainable looking back into 5-10 years and also comparing with the competitors to see if there is an explanation of better operating margin from the rest of the pack.
When it comes to analysts' expectations, I usually take them with a grain of salt. I don't give them much weight, as their assumptions often tend to follow market trends rather than predict them.
For 12%, it is better to be on the safer side :)
Makes sense. Revenue is hard to manipulate, as you go farther from top line it's more susceptible to manipulation.
Exactly!
I have explained my approach to this here:
https://www.moatmind.com/p/discounted-cash-flow-to-internal-rate-of-return
Without assumptions you can't value any company. Assumptions are necessary because we are trying to forecast future.
What do you propose?
Alternative 2:
Remove the unknown future growth, no replacement.
Discount rate takes inflation rate.
Replace FCF with dividend.
Replace the number of years as remaining life with infinity to compensate the removal of future growth and the much lower dividend.
A company which does not distribute dividends, but fork out huge compensation/remuneration package for directors, is a crook, it is suitable for short term speculative gaming, but not a candidate for long term investment.
Example:
Number of years = 999999999 (represent infinity)
Discounted DPS
=
0.028×(1÷1.03)×(1−(1÷1.03)^999999999)÷(1−(1÷1.03))
= $ 0.9333
Basically, if I understand your methodology above, you are just adding a bunch of more assumptions, including some macro-level assumptions, to value a company. I do not think that is unnecessary, making it way more complex for no reason.
There is no logic whatsoever to do all that math to figure out a company's value.
"It is better to be precisely right than absolutely wrong"
Hi Pablo, nice effort! As I mentioned in my other post (https://www.moatmind.com/p/discounted-cash-flow-to-internal-rate-of-return), DCF involves a lot of assumptions. You can compare your approach with mine here—I’ve also shared a link to the Google Sheet in this post above. Feel free to ask if you have any specific questions.