A fundamental question: DCF

[DesertCat]

Buffett doesn't do DCF calculations, Charlie Munger has some quotes on it you might be able to google. You can't use CAPM, Charlie has some even more pointed quotes on that, basically since it's built on Beta makes it untrustworthy.

I don't anymore either, I once modeled the DCF values of a bunch of different growth rates and got a feel for the results, they corresponded fairly well with Graham's formula. So today I'd just use his formula as a rule of thumb. My guess is Buffett does something similar but not sure.

The problem with DCF estimates is that small changes over long periods can lead to very large changes in valuations. What is more important than if one business has a 17.7% growth rate or a 18.9% growth rate, is the quality of the business. How strong is it's moat, it's return on capital, how good is the quality of it's cash flows, etc.

[adios]

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the thing about CAPM that sucks is if a company (look at USG) gets killed due to some temporary bad news or because of a downturn, its beta goes through the roof. Now you are supposed to say due to the stock markets short term outlook and irrationality the fundamental business has changed? People wont need drywall in the future? To me this makes no sense and thus Beta is pretty worthless when being used to discount cash flows.

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The article is right regarding DCF and calculating it. Actually your quibble is with beta as a measure of risk. It has it's limitations, what's a better way to go? I know some other ways but just interested in what you think.

Also for OP, Evan mentioned Damodaran's web site in another post, I would recommend it highly as well.

[adios]

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.... The problem with DCF estimates is that small changes over long periods can lead to very large changes in valuations. ....

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This statement is most definitely true. I guess that helps explains why valuations can and do fluctuate alot.

[DesertCat]

BTW, this is Graham's formula for IV. Note the second version that takes into account relative interest rates, ala DCF.

As the wikipedia article describes, just because you run a stock through this formula and it spits out $30 per share doesn't mean the company is worth $30 per share. A value investor would strive to buy the company at a large discount to intrinsic value, say 50% or $15. Plus Graham's formula assumes the growth rate will continue for 7-10 years, you can't directly apply it to GOOG because clearly GOOG's growth rate will be much slower over the next 7 years than it has been over the last few years.

Also, it doesn't take into account debt levels or enterprise valuations. A heavily indebted company with negative book value is going to be worth less than the same exact company with $5 per share of free net cash.

And in the end as I previously described, you have to think about how good of a business it is, how good management is, etc , to really come up with a good estimate of future growth prospects. You can't just use after tax earnings if those are over/understated by excess depreciation or other factors.

So the formula is a good tool, but you really have to understand the business and make adjustments before it's result is very useful.

In the case of NICK, one of my positions, I simply said, it's growing PE at 20%+ per year, yet has a 10 PE (at the time) so it was clearly attractive. After enough research so I could be confident about mgmt, the business, and the financial reporting, I bought. It wasn't a decision that needed multiple decimal points of accuracy. It was just screamingly cheap, something I still believe today. Of course it hasn't worked out so great lately, that one (though I originally bought a good amount of shares well below todays price). Eventually I'll either be right or dead

[critikal]

I've heard that many use the 10year treasury rate, though I'm pretty sure you are supposed to use the WACC. Just make sure you use a large margin of safety and you'll do fine with it.

[adios]

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I've heard that many use the 10year treasury rate, though I'm pretty sure you are supposed to use the WACC. Just make sure you use a large margin of safety and you'll do fine with it.

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Are you placing a value on equity or the enterprise? Anyway DCF is a starting point for understanding the fundamentals of valuation.

Might find this link interesting regarding WACC and Cost of Equity.

DCF Valuation

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As DesertCat pointed at, DCF has to be taken with a grain of salt since there are so many assumptions; you can basically toy with the model to get the results you are looking for. When analyzing a stock, I like to still do a DCF to get a feel for how the company makes money.

[SlowHabit]

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I've heard that many use the 10year treasury rate, though I'm pretty sure you are supposed to use the WACC. Just make sure you use a large margin of safety and you'll do fine with it.

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Are you placing a value on equity or the enterprise? Anyway DCF is a starting point for understanding the fundamentals of valuation.

Might find this link interesting regarding WACC and Cost of Equity.

DCF Valuation

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Does anyone know how good is Damodaran? I was excited upon visiting his website and free books but got very discouraged when I saw the word Beta in his valuation equation [img]/images/graemlins/frown.gif[/img]

[adios]

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I've heard that many use the 10year treasury rate, though I'm pretty sure you are supposed to use the WACC. Just make sure you use a large margin of safety and you'll do fine with it.

[/ QUOTE ]

Are you placing a value on equity or the enterprise? Anyway DCF is a starting point for understanding the fundamentals of valuation.

Might find this link interesting regarding WACC and Cost of Equity.

DCF Valuation

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Does anyone know how good is Damodaran? I was excited upon visiting his website and free books but got very discouraged when I saw the word Beta in his valuation equation [img]/images/graemlins/frown.gif[/img]

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Stupid reason and he talks about many ways to arrive at valuations of assets.