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Subject:  Re: Discounted Cash Flow Model - Negative FCF Date:  2/3/2011  6:20 PM
Author:  PaulEngr Number:  1629 of 1675

I have been looking at a company with negative cash flow and having a hard time modeling negative cash flow. It is a young company which is why I am looking at it.

These types of companies are harder to value than others because essentially EVERY input is a guess.

Probably the two easiest things to determine are the terminal value...basically, 2-3% (number isn't really critical), and the competitive advantage period (CAP). The CAP is not too hard to imagine in some industries. For instance in the CPU business (Intel, AMD), each "generation" is roughly 5 years. So the CAP is about 5-7 years. In others (Walmart for instance) it's harder to figure...but looking at for instance the rise and fall of Sears or K-mart from a historical perspective might give you some insight. At this point I'm figuring that Walmart is getting pretty close to the end. Amazon had a first generation and now (with Kindles) appears to be on the leading edge of the second run.

Then you've got to estimate growth rates. This is kind of tricky to do but for a young company, their publications with respect to their business model will probably yield a lot of clues as to reasonable numbers to plug in to produce the usual sigmoidal shape.

Then last for companies in the "negative" (development), you've got to look at their cash burn rate both currently and expected as they come into existence as a company.

In the end the problem with these is that essentially you have to construct a marketing estimate. But it's not impossible. For instance MCP (supposed to come online this year) will ultimately settle down to roughly a $30/share stock. Right now the speculators have driven it up to $50/share, and Chinese investors doing pump-and-dump on the market with their announcements about restricting exports of rare earths which is highly unlikely to happen given the Chinese economic situation (read John Mauldin for some idea about international trade trends though recognize that he's a permabear).

So I used this to buy in the $30's, rode it up to almost $60 when China made another one of their market manipulation announcements, sold a protective put (because it's hard to predict these momentum investment things), and laughed all the way down to about $45 as I stayed locked with most of my profit intact.
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