DCF: Hall of Shame (1)

Interesting article from Professor Aswath Damodaran:

"DCF Myth 1: If you have a D(discount rate) and a CF (cash flow), you have a DCF!"

He defines "the consistency test" for DCF:

• Unit consistency
• Input consistency
• Narrative consistency

And continues:

"Many of the DCFs that I see passed around in acquisition valuations, appraisal and accounting  don’t pass these consistency tests. In fact, at the risk of being labelled a DCF snob, I have taken to classifying these  defective DCFs into seven groups:"

Followed by the seven DCF groups and their description. The following picture gives some insights:

From the above we can see that there are many pitfalls in making a correct DCF. That is a serious problem with DCF.

But I think there is an even larger problem: dishonesty from the side of the DCF modeller. In the Malaysian context (and may be even in the global context), that is in my opinion a huge problem.

I will detail my reasons for this in a subsequent posting.

Are you a value investor? Take the Apple test

Interesting posting from Prof. Ashwan Damodaran about Apple on his blog "Musings on Markets".

He writes:

"Based on my estimates, and they could be skewed by my Apple bias, at its current stock price of $440, there is a 90% chance that the stock is under valued."

 

Plus 5 investment tips from the professor:

1. Don't bet the house: No matter how confident you are in your value assessment, don't go overboard and invest a disproportionate amount of your portfolio in Apple. This is not just about you being right on the value but also about the market coming around to your point of view, and that is not in your control or mine; betting more than 10% of your portfolio on this stock strikes me as foolhardy.
2. Don't double down (Dollar averaging): I have never been a fan of dollar averaging, which not only muddies the water about when/how much you invested in a stock but results in increasing your bets as the market goes against you. Take a stand against the market but do not make this an ego trip, where admitting that you are wrong becomes impossible to do. Thus, while I feel more confident now that the stock is under valued than I was a week ago when I bought the stock for $500, I don't plan to buy more shares.
3. Think of buying the business, not the stock: The old adage that you are buying a piece of a company, not a share of stock, is particularly relevant when you make a bet like this one. My intrinsic valuation is determined by Apple's capacity to generate profits and cash flows and is not dependent upon whether portfolio managers are investing with me or analysts are lowering their price estimates. If I buy Apple at $440 today and I can hold the stock, I will get a share of a cash that is paid out and a share of ownership in the cash that is withheld. I have to keep reminding myself of that truth, even if the market moves against me.
4. Do not track the day to day stories: In an increasingly connected world, I know that this is really difficult to do, but there is no harm trying. Turn off your financial news channel, don't read opinion stories about Apple and avoid equity research reports like the plague.
5. Be willing to wait... even if you are not sure what you are waiting for: The big question that those of us who chose to make this bet face is what the catalyst will be that brings the market back to its senses (at least as we see it...). From my experience, it is almost impossible to tell. For instance, how did Netflix, which was a tailspin, a year ago, turn itself around? There was no single precipitating event but a collection of small news stories and solid earnings reports that seemed to settle the fears that investors had about the company's future direction. With Apple, it could be a new product, a couple of healthy earnings reports or a stock buyback.

Disclosure: I have also started to buy some shares of Apple at USD 450, knowing very well that the share might easily go down further.

At the start of each year, Damodaran constructs a spreadsheet with fundamental data from each listed stock. The dataset can be found here. Malaysian and Singaporean stocks can also be found under "emerging markets", in the rather peculiar category "Small Asia". I recommend to first download the file to disk and then to work on it. It might be interesting for value investors who like to work with  filters to find some value ideas.