How discounted cash flow models work (and don't work)
CJ - great post. I agree with all these comment on DCFs, and in the same vein for me, doesn't this also apply to the idea of customer lifetime value if you are using discount rates? As interest rates have shot up, hasn't it blown up the economics of many businesses?
I've always been a bigger fan of the reverse DCF, but this can only be done with public assets. Starting with the stock price and backing into the range of assumptions -- sales growth, margins, investment requirements -- to justify the price. I find them much more informative. Don't ignore the stock price. Its telling you something.
I also like this Mauboussin paper, which uses current stock price to figure out market implied ROIC. Its like a reverse DCF, but expectations of a company's ROIC. I know it uses WACC - I dislike the WACC too.
I agree with the sentiment that no methodology is perfect and you indeed have to try something. Thanks for the great discussion points
I can’t agree more on each line. DCFs are dangerous.
(As someone who made DCFs for a living)