# Who uses Discounted Cash Flow (DCF)?



## pattyp (11 May 2008)

Curious to know what % of investors/traders use a custom made Discounted Cash Flow (DCF) model/tool...?

...and what are the key items/methods you employ... I'm especially curious about how people apply risk offsets and what final measure they focus on. eg. Fair Value, NPV, IRR...etc


References for those unfamiliar with the subject
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http://www.incademy.com/courses/Ten-great-investors/-Warren-Buffett/1/1040/10002

"Buffett uses a calculation known as 'discounted cash flow', or DCF for short. This involves estimating the future cash flows of the business, and discounting these back to a present-day value by applying the rate of return you could otherwise get, with no risk, by putting your money into a benchmark bond, say 10-year UK gilts. This shows whether there is a gap between the current and projected values of the business which is wide enough to give you your margin of safety."


http://www.buffettsecrets.com/price-to-pay.htm

"This method of valuation is often referred to as the Discounted Cash Flow (DCF) valuation method, but, as Buffett has said in relation to shares, it is not easy to predict future cash flows and this is why he sticks to investment in companies that are consistent, well managed, and simple to understand. A company that is hard to understand or that changes frequently does not allow for easy prediction of future earnings and outgoings."


http://www.berkshirehathaway.com/letters/1994.html

" We define intrinsic value as the discounted value of the 
cash that can be taken out of a business during its remaining 
life.  Anyone calculating intrinsic value necessarily comes up 
with a highly subjective figure that will change both as 
estimates of future cash flows are revised and as interest rates 
move.  Despite its fuzziness, however, intrinsic value is all-
important and is the only logical way to evaluate the relative 
attractiveness of investments and businesses."


http://www.investopedia.com/terms/d/dcf.asp

A valuation method used to estimate the attractiveness of an investment opportunity. Discounted cash flow (DCF) analysis uses future free cash flow projections and discounts them (most often using the weighted average cost of capital) to arrive at a present value, which is used to evaluate the potential for investment. If the value arrived at through DCF analysis is higher than the current cost of the investment, the opportunity may be a good one.  
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## reece55 (11 May 2008)

*Re: Who uses Discounted Cash Flow (DCF)*



pattyp said:


> Curious to know what % of investors/traders use a custom made Discounted Cash Flow (DCF) model/tool...?
> 
> ...and what are the key items/methods you employ... I'm especially curious about how people apply risk offsets and what final measure they focus on. eg. Fair Value, NPV, IRR...etc
> 
> ...




I use DCF to identify opportunities that I consider to be value at any point in time.

Because of the subjective nature of the valuation method, I tend to use the KISS principal - calculate estimated maintainable EBITDA, factor in PP&E costs and any increases in required working capital. The work out a growth rate (the most subjective portion of the process), apply a suitable discount rate (I tend to use about 500 - 600 bps above the cash rate) and work out the NPV. NPV/(Share Capital + potential dilutive shares) = Valuation per share and this is obviously what I focus on.

At the end of it, the DCF to me is like doodling - I want to confirm my gut feel about the business. There are other factors to consider, like gearing and accounting methods employed, but they are subjective and individual. But it gives a good picture of whether the business is worth a go.

Then, I use technical analysis to get my entry point..... They both go hand in hand IMO.

Cheers


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## pattyp (11 May 2008)

*Re: Who uses Discounted Cash Flow (DCF)*

Good to hear Im not the only one using DCF... LoL! 

I tend to use DCF as my Rule not exception, when analysing a co. for investment... It forces me to understand the proposed business because i need to investigate their market, cost, capital, and plan in more detail then most usually bother.

I focus mainly on Fair Value as an indication of Market Cap...and look at NPV @ 5%/10%/15%/20%....

I represent risk by using a Risk Ratio (Percentage) that I run over my Final Free Cash Flow.. This impacts my NPV, IRR and Fair Value. If there is good upside in the (Fair Value * Risk) vs. Real Life Mcap I tend to buy anything below my risk offset Fair Value. 

I also divide my Fair Value by the Diluted Shares + future dilution to get a price per share value.

And I have a lot of respect for TA. Again similar to you, I use TA  to pick good times to buy and also to keep myself entertained while waiting for the investment pay day 

Cheers,
Pat


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## pattyp (13 May 2008)

So no one else uses a DCF for their longer term investments...?


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## doctorj (13 May 2008)

Some other threads you might be interested in:
https://www.aussiestockforums.com/forums/showthread.php?t=9980&highlight=discounted+cashflow https://www.aussiestockforums.com/forums/showthread.php?t=7235&highlight=dcf https://www.aussiestockforums.com/forums/showthread.php?t=6571&highlight=dcf https://www.aussiestockforums.com/forums/showthread.php?t=2720&highlight=dcf https://www.aussiestockforums.com/forums/showthread.php?t=6169&highlight=dcf


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## 2BAD4U (13 May 2008)

My model is currently a work in progress but at this stage includes a couple of elements that I am trying to refine/improve and then I can back test it.

Essentially it is based around CAPM and dividend growth/yield to come up with a rating of if a share is undervalued, overvalued or neutral.  The next part I am working on is the criteria I will use to trigger a buy/sell once I have an undervalued or overvalued rating.


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## pattyp (13 May 2008)

doctorj said:


> Some other threads you might be interested in:
> https://www.aussiestockforums.com/forums/showthread.php?t=9980&highlight=discounted+cashflow https://www.aussiestockforums.com/forums/showthread.php?t=7235&highlight=dcf https://www.aussiestockforums.com/forums/showthread.php?t=6571&highlight=dcf https://www.aussiestockforums.com/forums/showthread.php?t=2720&highlight=dcf https://www.aussiestockforums.com/forums/showthread.php?t=6169&highlight=dcf




Bla ha ha ha! DoctorJ, some of that was hilarious... And some was very, very good reading!

Cheers... Appreciate your efforts!


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## pattyp (13 May 2008)

2BAD4U said:


> My model is currently a work in progress




2BAD4U - I think all methods are a 'work in progress'.. If they are not then we would never get any better 

Keep up the good work, interested to hear about your progress!

Pat


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