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No. of Recommendations: 14
I think "strongly recommending against this equation" is a little strong.

I used the word "strongly" to make it, well, strong. I can make it stronger if you wish but wont make it weaker. Here you go: I extremely strongly demand that you don't consider this equation.

It's certainly not going to hurt for people to investigate it for themselves and understand the underpinnings of it.

In order to be able to understand why you don't want to use the equation you need to first understand valuation. If you understand valuation there's no need to understand that equation so you can start and stop with variants of the dividend-discount model (DDM).

I was talking with Bill Mann today and we were discussing discounted cash flow analsysis. The problem with DCF, in my mind, is that with so many proponents of it, everyone is looking at it.

This I can't understand. We know how to value stocks. Period. Stocks are valued by the DDM of which DCF is one variant. Everyone is looking at it because it is a correct method to value stocks. This I can't understand is a problem.

It's not like a company's intrinsic value is the great unknown to people who follow DCF religiously

Sure it is because different investors valuing the same company using DCF will come up with different intrinsic values as result of different assumptions. People using other variants of the DDM will come up with yet different values. To become a successful value investor you need superior skills in applying DDM variants, not to be looking for alternative approaches such as Graham's equation.

The real problem is that the risk you assume has little or nothing to do with running a solid DCF because truly undervalued companies by traditional DCF standards are ONLY undervalued because there is doubt amongst market participants as to whether the future cash flows can remain in tact.

I don't agree with thus. The risk you assume has everything to do with running a solid DCF. The more uncertainty about future cash flows, i.e. the higher risk, the lower intrinsic value and thus the less likely it is that the company is undervalued. Evaluating risk is a key component of DCF, as important as getting the expected cash flows right.

Philip Morris is a perfect case in point. By all traditional DCF measures, it's been dirt cheap for some time now, and especially last year.

That's not clear to me because traditional DCF measures should take the substantial risk of tobacco companies these days into account. Whether a correct DCF will render Philip Morris undervalued remains to be seen.

The real risk that you took was whether those cash flows would remain in tact. That's where the risk is assumed, at least for most large companies that are widely followed.

It sounds like you don't consider risk to be a part of the DCF but it is. If you ignore risk and discount Philip Morris' expected extractable cash flows at a bond rate clearly it looks undervalued. However, you haven't performed a proper DCF analysis because you didn't increase your discount rate to account for risk.

I challenge you to show me a single company that's trading at a significant discount to future cash flows where the predictability or even stability of those cash flows isn't in doubt.

Again, you need to understand that risk-adjustment is part of the DCF. Let me turn the table and challenge you to find a single company trading at a significant discount to a DCF valuation where the predictability or even stability of those cash flows is in doubt.

While DCF needs to be in the holster, it too is not the be all and end all.

As the equivalent of the DDM, DCF is all and end all.

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