Present Value of Future Cash Flows
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chops_a_must
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Really good thread guys.
I'm curious to know with whatever fundamental, value, cash flow method you use, how do you come to a price you are willing to buy at?
Are you able to give an example?
It just seems like a lot of analysis without reaching a final figure.
Cheers.
I'm curious to know with whatever fundamental, value, cash flow method you use, how do you come to a price you are willing to buy at?
Are you able to give an example?
It just seems like a lot of analysis without reaching a final figure.
Cheers.
I use a discounted cash flow model. Like any valuation model it is only as good as the assumptions that you put in! The model itself is simple. Enter cashflows for each half year / year of your forecast range, pick a discount rate and discount all of the cashflows back to year zero (ie the present). Then as we were discussing above you need to come up with a value for the cashflows outside of the forecast period or you at least a proxy for the net value of the assets of the company.
A model may look like:
http://www.stern.nyu.edu/~adamodar/pc/eqegs/Brahma.xls
This is from Aswath Damodaran.
I'm afraid I wouldn't post my own as a) it would be useless to anyone who had not made the assumptions within (ie. probably everyone but me!) and b) I don't want people relying on the figures.
It find it an enjoying challenge - most companies I look at I will never value. The DCF model is the very last input, if I cannot find anything to get too excited about (which is the vast majority) then I move on in peace. Perhaps make a note for future review.
I usually only spend an hour (or two max) per night on research, so it's not too strenuous.
chops_a_must
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I use a discounted cash flow model. Like any valuation model it is only as good as the assumptions that you put in! The model itself is simple. Enter cashflows for each half year / year of your forecast range, pick a discount rate and discount all of the cashflows back to year zero (ie the present). Then as we were discussing above you need to come up with a value for the cashflows outside of the forecast period or you at least a proxy for the net value of the assets of the company.
A model may look like:
http://www.stern.nyu.edu/~adamodar/pc/eqegs/Brahma.xls
This is from Aswath Damodaran.
I'm afraid I wouldn't post my own as a) it would be useless to anyone who had not made the assumptions within (ie. probably everyone but me!) and b) I don't want people relying on the figures.
It find it an enjoying challenge - most companies I look at I will never value. The DCF model is the very last input, if I cannot find anything to get too excited about (which is the vast majority) then I move on in peace. Perhaps make a note for future review.
I usually only spend an hour (or two max) per night on research, so it's not too strenuous.
Very good.
That's what I was after - a spreadsheet that I could use or make myself with some inputs.
Probably a good starting point for me to learn, and find out more about what those inputs are.
Is there a preferred method for growth stocks? As I know that's what I have a bias towards, in my trading.
Aswath Damodaran has some good papers on his site. He covers all bases. Just beware it isn't highly organised (well I don't think it is) but if you want to start from scratch it's a good free source.
He also has a book called "Little Book of Valuation" which covers the basics of this and other models / methods. I picked it up for about $20 in store. Probably cheaper online!
The best way to think of a model is merely a way of expressing the cash flows - there may be a growth period in the initial years, then a maturing period, then stable growth.... or the whole business could be very cyclical. Learn the maths (or how to program MS Excel) and you can build your own easily. The NPV function in Excel is great.
chops_a_must
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Thanks.
I'm handy with excel so looking for the maths and parameters to be able to get to what I want.
I find too much on the topic tells me about cash flow and earnings and all the rest, but never actually tells me about what that should mean for price.
The first couple of minutes of that video have been my major lesson for the year.
I developed my approach in relative isolation and it works best when I do lots of specific company research that result in few but important actions. To avoid overstimulation and the urge to DO more then I really should under my approach I have dialled the noise back and almost instantly refound the clarity and perspective that had slowly and silently slipped away as I indulged in other peoples thinking on forums.
So indulgence over again for this visit - Back under my rock again.
Happy Investing – catch you infrequently.
Anybody been watching the Aus Bond Yields in the last few days?
We may like a lower $ but as a net importer of capital we can’t afford it at the expense of too high a bond yields. Limiting factor for RBA in cutting rates to address domestic situation.
We may like a lower $ but as a net importer of capital we can’t afford it at the expense of too high a bond yields. Limiting factor for RBA in cutting rates to address domestic situation.
Easy in hindsight to say when the end will occur.
MMS has been pretty fully priced on and off for quite a while. But the price largely run in line with the underlying business results and without knowing a certain end date for novated leasing (which seemed de-risked with the implementation of the Henry recommendations) the overpricing never really amounted to enough to compensate for tax and give a MOS on the sell decision. (note: some were sold purely on max position size rules)
Nothing is easy with this business now. The earnings stream potential is more variable as if FBT for cars doesn’t end the competition will be less and the margins fatter / the earnings down side remains the same (Bad but not out of business by any means) although time will help mitigate to some degree. The big unknown is that sentiment and hence earnings multiple is now in play.
A spooked market trying to find a suitable earnings multiple on an earnings stream that has a higher variability and visibility of probabilities. Yep things have changed. But getting out to avoid this scenario was not a clear-cut decision prior to the announcement.
Trade management to avoid this situation would have either seen you not enter or out at $4, $6, $8.... I don’t know exactly where but not perfectly at $18 or even well at $12, $14 or $16. Is complacency just a hindsight charge or is there more to it?
I’ve reflected on this investment and am happy with the entry decision, position sizing and the trade management, however I’m a bit close for an unbiased POV so would be pleased to see you extend the complacency argument for MMS. If the charge of complacency is valid this is the damage I have needlessly incurred. – The equity curve for the super account where this investment sits. (the trading to mitigate is in another account) July drawdown basically = MMS.
Unavoidable in the larger picture I accept – Complacency, I can’t afford, so don’t hold back why was holding complacent ‘in real time’?
skc
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Craft,
I think there are two parts to your answer.
1. While I agree that post-Henry tax review one would quite reasonably assume MMS will be business as usual for a while (3-5 years?), the tail risk was still real. Yes the PE multiple was a function of the earnings growth, but market neglected the risk in the earning growth itself. I don't really know how to price the tail risk, but the way MMS was priced, the tail risk was probably priced close to zero. It is a known unknown so definitely knowable in real time - and you know that based on our exchanges on the MMS thread around Dec 12. This was Citi's analyst report on 1 July
To me they forgot that the tail risk in MMS case exists in perpetuity, so there's an element of it that should never be discounted.
2. Complacency by the market in pricing MMS on a standalone basis does not necessarily mean you were complacent when it comes to holding MMS. You may be well aware of the risk, and choose to hold for the right reason. MMS is only a part of your portfolio and you have your own rules about buying/selling/sizing etc which you followed. Perhaps there could be improvements such as extra MOS on entry, reduced MOS on sell decision, limit position size or portfolio exposure etc, on positions subjected to known tail risks. These are some potential passive risk management options.
There's one thing that is most interesting with MMS. I can't remember at what time Rudd released the proposed FBT changes, but MMS traded until 11:01am before announcing a trading halt, with the share price having fallen ~15%. If a holder had kept the tail risk consideration in their mind, they would have envisioned the scenarios when such tail risk eventuates (it would be from sources external to the company), and they could have set up additional safeguards for this type of investment. Eg. real time news alert, excessive price move alert etc. The safeguards may or may not work everytime (MMS could have gone into the trading halt before open), but they should be in place nonetheless. This would be a more pro-active risk management approach.
So were you complacent in real time? The question is simply... did you mis-price the risk, or did you NOT price the risk. I don't have the answer... and I defenitely didn't do any better.
I think there are two parts to your answer.
1. While I agree that post-Henry tax review one would quite reasonably assume MMS will be business as usual for a while (3-5 years?), the tail risk was still real. Yes the PE multiple was a function of the earnings growth, but market neglected the risk in the earning growth itself. I don't really know how to price the tail risk, but the way MMS was priced, the tail risk was probably priced close to zero. It is a known unknown so definitely knowable in real time - and you know that based on our exchanges on the MMS thread around Dec 12. This was Citi's analyst report on 1 July
To me they forgot that the tail risk in MMS case exists in perpetuity, so there's an element of it that should never be discounted.
2. Complacency by the market in pricing MMS on a standalone basis does not necessarily mean you were complacent when it comes to holding MMS. You may be well aware of the risk, and choose to hold for the right reason. MMS is only a part of your portfolio and you have your own rules about buying/selling/sizing etc which you followed. Perhaps there could be improvements such as extra MOS on entry, reduced MOS on sell decision, limit position size or portfolio exposure etc, on positions subjected to known tail risks. These are some potential passive risk management options.
There's one thing that is most interesting with MMS. I can't remember at what time Rudd released the proposed FBT changes, but MMS traded until 11:01am before announcing a trading halt, with the share price having fallen ~15%. If a holder had kept the tail risk consideration in their mind, they would have envisioned the scenarios when such tail risk eventuates (it would be from sources external to the company), and they could have set up additional safeguards for this type of investment. Eg. real time news alert, excessive price move alert etc. The safeguards may or may not work everytime (MMS could have gone into the trading halt before open), but they should be in place nonetheless. This would be a more pro-active risk management approach.
So were you complacent in real time? The question is simply... did you mis-price the risk, or did you NOT price the risk. I don't have the answer... and I defenitely didn't do any better.
Bumping this old post. Apologies for the grave-digging.
Perpetuity calculations are still giving me doubts for most of the reasons you have outlined in this thread.
Statistics say that most companies arguably will not be around in 20 or 50 years and if they do make it that far it is unlikely that their competitive advantage will last that long. Sustainable competitive advantage is very rare universally it would appear from the history books. In other words; librarians may not be rich, but they still have interesting things to say!
It is probably with my own laziness / having other priorities / lack of knowledge / insert other excuses here that I have no tried to approach the problem from a different angle until now. The art is there and seems to function to an extent; but in my opinion it needs refining.
So how else to approach this problem?
My reading efforts and my own thoughts, and a quick read through this thread and a couple of others offer a few solutions. Generally in the form of an equity multiple (which is relative to the market - possibly undesirable in itself) or a figure based on the replacement / entry costs of a new entrant / competitor to replicate the firm's assets and business model.
Greenwald discusses the concept of replacement value of assets + adjustments for entry costs (marketing, sales knowledge, R & D and other things that make up the raft of intangible assets that centre around terms like "brand" and "intellectual property.") It is a good starting point.
A few quick questions whilst they are fresh on my mind, if I can?
When completing a DCF do you add the replacement cost of assets at their net present value (since I assume they are based on current values from the most recent financials plus or minus the adjustments that you choose to make) or do you discount them from the period immediately following your last cash flow projection?
I read a bit of Damodaran occasionally too (at your kind recommendation!) - but no where have I found the concept of using a multiple for the replacement asset value. I am guessing that you developed this in isolation yourself and refine it through experience and knowledge of other concepts that you have come across. It makes sense as a concept; but like any valuation the data input would be arbitrary in nature and I imagine the multiple used could dictate have a big effect on the terminal value. Would like your comments on this, even if it is only a very, very gentle push in the right direction.
Thank you for the explanation via PM - it does give me a starting point for my questions here and a bit of the reasoning that goes in behind it.
Part of the problem may be that I am making this more complicated in my own mind than it actually is - the simplicity will no doubt come out when the penny drops.
It would appear that those three chapters on enterprise valuation in Greenwald are a lot closer to what I am looking at doing than I would have thought before skimming over them again last night. Looks like you have put your own twist on them, but kept the basic framework and principles?
Some more reflection on MMS investment.
MMS re-acquainted me with scalability issues in absolute dollar terms. Relevance, percentage thinking etc etc all fine until your bloody brain starts involuntarily obsessing on volatility calculated in terms of X number of years of average wages; donation; cars; houses; planes; boats; holidays whatever your measurement unit of meaningfulness may be.
Final wash up I am only going to make 1 change to my approach which led MMS to appear and stay in my portfolio and that is to adjust maximum portfolio exposure for known tail risk. Long term I expect this to be a compromise in total returns (just as any arbitrary capping of winners is likely to do) but at this stage I’m willing to pay for a bit of emotional comfort and facilitate a more relaxed position from which to monitor developments.
Always learning.
MMS re-acquainted me with scalability issues in absolute dollar terms. Relevance, percentage thinking etc etc all fine until your bloody brain starts involuntarily obsessing on volatility calculated in terms of X number of years of average wages; donation; cars; houses; planes; boats; holidays whatever your measurement unit of meaningfulness may be.
Final wash up I am only going to make 1 change to my approach which led MMS to appear and stay in my portfolio and that is to adjust maximum portfolio exposure for known tail risk. Long term I expect this to be a compromise in total returns (just as any arbitrary capping of winners is likely to do) but at this stage I’m willing to pay for a bit of emotional comfort and facilitate a more relaxed position from which to monitor developments.
Always learning.
skc
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I don't know how you can divorce that when you are talking about your own capital... afterall that's why you accumulate capital and build wealth... so you can turn it into donations, cars, houses, planes, boats, holidays whatever.
To feel is only normal... to be able to act rationally despite the feeling is what you achieved and that's all you could have asked for imo.
It's only a compromise in return for that particular stock. If you deploy the released capital with the same efficiency then on average you are no worse off. You'd only be worse off if you believe, for some reason, that the average return for stocks with tail risks are greater than the return of all other stocks in your investment universe.
I don't know about you - but this is probably the worst "psychological" stock in my portfolio at the moment.
Every where you go that some relation to stocks, people, whether they are analysts or small investors or speculators, are talking about it. Lots of noise, and will to action. Something always has to be done, some small angle needs to be discussed like it is the most important thing in the world. It is not that I don't agree with some of the discussion or have the ability to separate it from my own thinking patterns.... but the fact that it is there, starts my own internal dialogue... and promotes some kind of mental activity, whether it be active thought or an effort to move on for now. Silence is a wonderful thing sometimes, and very beneficial. Doing nothing, not even thinking, until you need to again, should be cherished more often that it is.
Buffett's idea of only visiting Wall Street once a year resonates highly with me at times like these. Clearer, precise thinking, free of everyone else's emotions, plans, angles, yada yada. The dark room sounds good to me at the moment.
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Buffett's idea of only visiting Wall Street once a year resonates highly with me at times like these. Clearer, precise thinking, free of everyone else's emotions, plans, angles, yada yada. The dark room sounds good to me at the moment.
I've made a conscious effort as part of my New Financial Year's resolution to try and reduce the amount of crowd sourced opinions I listen to. I've found that in the past even when my thinking may be correct, having a roomful of other opinions will wash out my own. To be honest, I've found it liberating. I can see things with much more clarity or at least the things I think are important. Now if only I could get myself a nice villa on the beach in the Carribbean to "think".
I make the same vows i.e. stay clear of this forum.
I think I have even posted on here before the Buffett quote that resonates with me the most..
Problem Is I keep ignoring it because the likes of you three above/below keep posting insightful things to spark the mind and I keep coming back for a fix and then read a little bit more then post......
Oh for some balance....or is it discipline?
Try again.
