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Author: jackcrow Big gold star, 5000 posts Feste Award Nominee! Old School Fool CAPS All Star Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 1670  
Subject: Discount conundrum Date: 5/16/2011 12:50 PM
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I am very curious how other folks are deriving their discounts. Doing some research this weekend S&P consistently had companies valued substantially below where I would place them. I don't really care that S&P and I disagree. What interests me is that we all have access to the same public information. This means our FCF or adjusted earnings inputs can be reverse engineered and discovered. There really should be few surprises and the range of inputs should be fairly predictable.

We also know that for the most part various DCF methods are reconcilable with each other when we all start with similar inputs.

This leaves as the outliers near term growth, mid term growth(if 3 stage), terminal growth and discount. Growth projections are easy to come by, they are often published and changes to growth projections are often worthy of a press release. This leaves only the discount number hidden in the shadows.

Personally I use a built up discount that avoids the fallacies of beta.
Risk free
+company specific risk(appraised two ways, market assigned and market implied)
= cost of debt

Cost of debt
+equity risk premium
=equity risk

Apply appropriate capital structure division and I get WACC for FCFF/EVA. Straight equity risk would be applied to dividend discount or FCFE.

My current conundrum is that many folks in the media and on the boards are describing the current stock market as overpriced. My bottom up research disagrees. The difference has to lie somewhere in the discount because growth is known and starting FCF can be discovered and bracketed.

I also have a thesis that many folks are currently over pricing risk due to fear over the last meltdown and confusion or distrust of current macro economic trends. To be specific, if "risk free" is lower then everything built on it is lower. My suspicion is that folks are adding a risk premium to risk free, intentionally or unintentionally.

What say you?

jack
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