15 Comments
User's avatar
James's avatar

I don't bother with DCF calculations because I only invest in things where the value is obvious. Generally this means the company is trading cheaply on the basis of book value, its current earnings or those at most a couple of years out in the case of a recovery. In other words, I don't rely on growth to make an investment work.

Expand full comment
Kevin's avatar

Thanks for the feedback! I usually work with boundary conditions, like what the intrinsic value in a no-growth scenario looks like. But I mainly do the DCF to write down all assumptions. Your comment reminds me of something I read I think in Margin of Safety: Focus on the downside, and the upside will take care of itself...

Expand full comment
Antoni Nabzdyk's avatar

A really good read.

Expand full comment
Kevin's avatar

Thank you sir!

Expand full comment
ON OUR WAY TO THE MONEY's avatar

I define the value as the market price. Intrinsic value has never worked for me. Alibaba / my best example. US stocks seem to trade way too expensive. I was told stocks move towards this “intrinsic value” but it just has not worked on what I have tried. The only thing I can rely on is technical analysis at this point in my studies. Not giving up on fundamentals as I have only been trading about 6 years. Wild time to learn the markets. The internet does help though and feel fortunate that I have it while many of the researchers I look up to didn’t have that access.

Expand full comment
Kevin's avatar

I appreciate your feedback. It's our experiences that shape our investment journey. BABA is a controversial company, and I think I understand. Even at 300 USD, lots of people were saying it was trading below intrinsic value. The only thing I've learned is this all takes time. The combination of fundamentals and technicals seems like a good playbook!

Expand full comment
ON OUR WAY TO THE MONEY's avatar

It’s the best. I even use the seeking alpha quant analysis for ideas. They had SMCI as the top rated stock for a long time last year. Good wins to hedge against baba, but I plan to hold baba for possibly 10+ years. Cost basis is 88 / I don’t think it will rise to previous highs but when China’s real estate and economic conditions improve we probably will not see much upside. I just started reading “security analysis”. I want to get better educated with valuations. Need to get Brian Shannon’s books for better technicals. Have a good week

Expand full comment
ON OUR WAY TO THE MONEY's avatar

Mistyped about China / i think you understand what I intended. Thanks again

Expand full comment
Wolf of Harcourt Street's avatar

Great article Kevin. I personally find the journey of calculating a DCF more useful than the destination or answer. Mapping out how revenue, margins and cash flow will evolve over time requires a deep understanding of the underlying business and drivers. I find this to be the most valuable part of the exercise.

Expand full comment
Kevin's avatar

Couldn't agree more. I should have mentioned it like that in the article: It's the journey, not the destination. Thank you for your insights!

Expand full comment
Arny Trezzi's avatar

Deep and comprehensive article on valuation. DCFs are a tool to help us seek the truth, they should never be considered the truth. Great job Kevin!

Thank you so much for mentioning my article.

Reverse DCFs saved me many times by helping me focusing on what truly matters rather than on the assumptions I wished to see.

Expand full comment
Kevin's avatar

Man, that's a great summary of the article. I should put that quote on my wall!

Expand full comment
ParanoidAndroid's avatar

Hi Kevin, excellent thoughts. I have to admit I am more in the "rule of thumb" camp myself, though I do look at a large number of ratios before making an investment and not just at the (P/E) tip of the iceberg. It's probably also because my investment horizon is almost never more than 3-5 years. I just don't feel confident to predict that a certain business will continue to crush it in 10 years from now. For every celebrated Costco and Sea Candy out there, there are 100 other businesses that looked wonderful at a certain point but did not last, often for reasons that no one saw coming. If your horizon is only 3-5 years, do you really need to go full DCF? That's why I like special situations, where there's a distinct catalyst I am looking to unlock, rather than trying to play a DCF guessing game 20 years out. A good example is my recent investment into Adyen, where I just took an intuitive punt that all the various balance sheet, P&L and cash flow ratios were becoming way too pessimistic for what appears to be a high-quality double-digit growth business. But do I feel comfortable valuing Adyen on a DCF basis with assumptions about its growth 5, 10 or 20 years out? Of course not. And I am pretty sure that no matter how much information and insight you gain about a certain business, you just wouldn't be able to make that call. Too many variables. Just my two cents.

Expand full comment
Kevin's avatar

Thank you! I based my Adyen investment decision on a reverse DCF and also concluded that the growth rate the market was implying was too low. I understand your reasoning. I like the 'process that is behind a full DCF' because it forces me to lay out my hypothesis. But in addition to the DCF, I'll try to look at a football field of valuation measures. A bit like the screen you get when you look up a stock on gurufocus.com. Although for 'businesses in industries that do not change' I feel we often underestimate how long certain businesses actually last and as a result underestimate the value.

Expand full comment
ThinkValue.co's avatar

Hi Kevin, great post and thanks for the mention.

I typically use a reverse DCF as the first step in an analysis in order to find out what needs to happen in order for the stock to make sense. There are a few moving parts (typically growth and margins) but it works well to produce a range of expectations.

Expand full comment