DCF based projections

hunter · 26 Re: DCF based projections Mon Sep 16, 2013 9:36 pm

hunter

Moderator

Posts : 786
Join date : 2011-04-27

npp wrote:Good initiative. I did not give it a complete read but judging but seems a great effort. I'll be back to read this but on first impression I'm not getting the clear picture.

Jiggy has explained much. Also as mentioned in some comments, future cash flows too depend on a lot of assumptions. Good if you can note down some of yours if possible with others' who are following can contribute

Thanks all!!
Great ideas are coming up from everyone here. That's very encouraging.

Laughing

As you may have noticed, this topic was started accidentally and well before intended times. So it lacks my usual preamble to explain what I am talking about. Anyway, let me try to clarify a little.

I've been using (my own) different means to get an idea about the value of a share for sometime.
In the recent past, with the help of some of members, a formula was developed.

http://forum.srilankaequity.com/t29902-my-share-valuation-formula

The result was helpful. But there were limitations.
As in the case with usual DCF methods, When we calculate the present value for different projected years, the final result may differ. For example, a share may look good when 5 years are used but may look bad for 10 year projection. Then a question is coming should we use 5 years or should we use 10 years; and why?

To eliminate that confusion, I decided to find a method to give a 'snap shot' view of multiple (year) period projection. That's the reason behind initiating this tool.

For the time being, as inputs, I have used only published numbers; NAV, EPS and DPS. So the automatic assumption is, the current trend in earnings and dividends will continue in to the future. (I know that's contrary to the basis of usual DCF methods).
The discount rate used is 12%.
I have taken EPS instead of FCF; so another automatic assumption is, the remaining cash after paying divided is considered as capital expenditure. (This is also arguable).

ALSO:
Few words about how I intend to used this tool......
Right now, I remain as a medium term 'trader', therefore, I need not and do not intend to use this to judge or predict any future market price. (For that, I consider technical analysis).
But there will be many uses of this tool such as, to identify the shares with a higher chance of a price appreciation; to judge if a market price is justifiable by its value; to avoid very 'expensive' shares; and to see if a share worth averaging etc.
Another accident use I noticed was there are common characteristic of 'overvalued-high demand' shares (NEST, CTC etc).

Finally, I do not know 'DCF projection' is a good name for this tool. May be I need to think of a better name later. Smile

K.Haputantri · 27 Re: DCF based projections Tue Sep 17, 2013 11:36 am

K.Haputantri

Co-Admin

Posts : 2274
Join date : 2011-12-06

hunter wrote:My sincere thanks to everyone who commented.

I have had very limited exposure to accounting, so, would like to clarify a certain matter. Appreciate if someone can comment on the following.

As I understand, in the long run, Earnings and Free cash flow should show the same results. Whereas FCF would show big fluctuation time to time during capital expenditure; while Earnings would smooth out the Capex through depreciation.
* Am I correct?

On the other hand, manipulation of DCF figures are difficult compared to earning figures.

Anyway, assumed no figure manipulations, averaged earnings and DCF should give us the same results in NPV calculations.
* Should it?

If so, can we use Earnings instead of Free Cash in Discounted cash flow method?

Thanks in advance if someone can comment.

As far as I know, these are two different things. For earnings calculation depreciation, provisions for impairment of assets and accrued expenses for the period (whether paid or not) are deducted and what ever accrued income for the period (whether realised or not) is added. All expenses and income beyond the period (irrespective of cash payout or comming in) are not added and carried forward.

However, for FCF calculation only cash and cash equivalant resources available during the period (irrespective of their applicable period) are taken.

Slstock · 28 Re: DCF based projections Tue Sep 17, 2013 11:50 am

Slstock

Director - Equity Analytics

Posts : 6610
Join date : 2011-01-22

Hunter / O thers

I am the culprit who moved Hunters embedded posts in a another thread to open a separate topic . I felt the need as Hunter should get some recognition and input.

i see you got good feedback.

But if I have made things uncomfortable Hunter, do you want me to lock this thread until you are ready ?

hunter wrote:
As you may have noticed, this topic was started accidentally and well before intended times. So it lacks my usual preamble to explain what I am talking about. Anyway, let me try to clarify a little.

hunter · 29 Re: DCF based projections Tue Sep 17, 2013 12:27 pm

hunter

Moderator

Posts : 786
Join date : 2011-04-27

slstock wrote:Hunter / O thers

I am the culprit who moved Hunters embedded posts in a another thread to open a separate topic . I felt the need as Hunter should get some recognition and input.

i see you got good feedback.

But if I have made things uncomfortable Hunter, do you want me to lock this thread until you are ready ?

hunter wrote:
As you may have noticed, this topic was started accidentally and well before intended times. So it lacks my usual preamble to explain what I am talking about. Anyway, let me try to clarify a little.

Oh no ! Slstock, this is fine as a separate topic and it is more appropriate so now. In fact, you did a good thing as I learnt and learning from everyone's comments.
At the same time, I wanted to keep readers informed, since the topic was started accidentally, the content may be written in a little 'ad hock' manner. I feel that is also ok. (This is not going to be a PhD thesis Laughing

)

hunter · 30 Re: DCF based projections Tue Sep 17, 2013 12:33 pm

hunter

Moderator

Posts : 786
Join date : 2011-04-27

K.Haputantri wrote:

hunter wrote:My sincere thanks to everyone who commented.

I have had very limited exposure to accounting, so, would like to clarify a certain matter. Appreciate if someone can comment on the following.

As I understand, in the long run, Earnings and Free cash flow should show the same results. Whereas FCF would show big fluctuation time to time during capital expenditure; while Earnings would smooth out the Capex through depreciation.
* Am I correct?

On the other hand, manipulation of DCF figures are difficult compared to earning figures.

Anyway, assumed no figure manipulations, averaged earnings and DCF should give us the same results in NPV calculations.
* Should it?

If so, can we use Earnings instead of Free Cash in Discounted cash flow method?

Thanks in advance if someone can comment.

As far as I know, these are two different things. For earnings calculation depreciation, provisions for impairment of assets and accrued expenses for the period (whether paid or not) are deducted and what ever accrued income for the period (whether realised or not) is added. All expenses and income beyond the period (irrespective of cash payout or comming in) are not added and carried forward.

However, for FCF calculation only cash and cash equivalant resources available during the period (irrespective of their applicable period) are taken.

In that case, If you are correct, EPS should be better than FCF for use in this tool. (That's what I have done anyway). Thanks for your view.

Last edited by hunter on Wed Sep 18, 2013 2:03 am; edited 1 time in total

smallville · 31 Re: DCF based projections Tue Sep 17, 2013 9:50 pm

smallville

Associate Director - Equity Analytics

Posts : 4119
Equity Stars : 10300
Reputation : 530
Join date : 2011-02-03
Location : Back on Earth

How much a company earns for a share we buy is so worth than many things Wink

Either they giv it a dividend or make new investment thru it..

hunter · 32 Re: DCF based projections Wed Sep 18, 2013 7:28 am

hunter

Moderator

Posts : 786
Equity Stars : 7131
Reputation : 114
Join date : 2011-04-27

smallville wrote:How much a company earns for a share we buy is so worth than many things ;)Either they giv it a dividend or make new investment thru it..

That's obvious in theory.

But in reality, it seems, dividend acts as a measure of 'investor friendliness' and thus a booster in market price.

Suppose, NEST or CTC maintained same earnings but stopped dividend payouts. Would it affect market price positively or negatively?
Suppose RENU started giving handy dividends..?

K.Haputantri · 33 Re: DCF based projections Wed Sep 18, 2013 11:36 am

K.Haputantri

Co-Admin

Posts : 2274
Equity Stars : 9076
Reputation : 390
Join date : 2011-12-06
Age : 75
Location : Moratuwa

hunter wrote:

smallville wrote:How much a company earns for a share we buy is so worth than many things ;)Either they giv it a dividend or make new investment thru it..

That's obvious in theory.

But in reality, it seems, dividend acts as a measure of 'investor friendliness' and thus a booster in market price.

Suppose, NEST or CTC maintained same earnings but stopped dividend payouts. Would it affect market price positively or negatively?
Suppose RENU started giving handy dividends..?

Of course, a good divident pay-out affects market sensitivity & jackup prices short term, but it also reduces the cash resources it has for expansion, thus reducing the companie's worth long term. From a long term perspective, divident payments might reduce its market price.

hunter · 34 Re: DCF based projections Wed Sep 18, 2013 12:39 pm

hunter

Moderator

Posts : 786
Equity Stars : 7131
Reputation : 114
Join date : 2011-04-27

K.Haputantri wrote:
Of course, a good divident pay-out affects market sensitivity & jackup prices short term, but it also reduces the cash resources it has for expansion, thus reducing the companie's worth long term. From a long term perspective, divident payments might reduce its market price.

Excellent. That's a key point I was thinking about all this time.
If the business is expanding at a higher rate than the 'discounting rate', it make sense to reinvest earnings. Otherwise, it is better to give out as dividend.

The issue I want to solve is how to determine reliably what the business growth rate is.

hunter · 35 Re: DCF based projections Wed Sep 18, 2013 1:29 pm

hunter

Moderator

Posts : 786
Equity Stars : 7131
Reputation : 114
Join date : 2011-04-27

BTW: I think I should call, the model in discuss, something like 'Net Equity Present Value Projection'.
(Calling it DCF looks inappropriate and confusing.)

smallville · 36 Re: DCF based projections Wed Sep 18, 2013 2:54 pm

smallville

Associate Director - Equity Analytics

Posts : 4119
Equity Stars : 10300
Reputation : 530
Join date : 2011-02-03
Location : Back on Earth

hunter wrote:

smallville wrote:How much a company earns for a share we buy is so worth than many things ;)Either they giv it a dividend or make new investment thru it..

That's obvious in theory.

But in reality, it seems, dividend acts as a measure of 'investor friendliness' and thus a booster in market price.

Suppose, NEST or CTC maintained same earnings but stopped dividend payouts. Would it affect market price positively or negatively?
Suppose RENU started giving handy dividends..?

Multinationals aint gonna stop giving heft dividends, are they? They need to take money back to their home countries. So competitive dividends are their policy.
On the contrary, if they stop, market response will be bad too.. Lot of ppl go for these shares despite there's growth or not cuz they give 4 dividends and that's a solid investment I'd say.

But companies must not give big dividends at the stage of growing just to make the shareholders happy. And what if VONE dont give dividends in coming qtrs, years? Would it mean VONE is not a considerable company for growth?

hunter · 37 Re: DCF based projections Wed Sep 18, 2013 3:48 pm

hunter

Moderator

Posts : 786
Equity Stars : 7131
Reputation : 114
Join date : 2011-04-27

smallville wrote:
Multinationals aint gonna stop giving heft dividends, are they? They need to take money back to their home countries. So competitive dividends are their policy.
On the contrary, if they stop, market response will be bad too.. Lot of ppl go for these shares despite there's growth or not cuz they give 4 dividends and that's a solid investment I'd say.

But companies must not give big dividends at the stage of growing just to make the shareholders happy. And what if VONE dont give dividends in coming qtrs, years? Would it mean VONE is not a considerable company for growth?

Yes, I've also been arguing myself in the same line; Earnings, dividends, asset values and growth are key to asses the share value. And decided how to incorporate Asset value, Dividends and earnings in to a model.

The problem I am facing is how to calculate a business/asset growth rate in a simple way based on past or present published data; (without taking any hypothetical/speculative estimates).

Jiggysaurus · 38 Re: DCF based projections Wed Sep 18, 2013 8:21 pm

Jiggysaurus

Assistant Vice President - Equity Analytics

Posts : 962
Equity Stars : 6541
Reputation : 68
Join date : 2012-06-14

hunter wrote:

The problem I am facing is how to calculate a business/asset growth rate in a simple way based on past or present published data; (without taking any hypothetical/speculative estimates).

If you don't want to do any gilmarting on future forecasts, take the 5 year earnings/asset CAGR (for the CSE it may be better to take the 3 year CAGR)

Academic · 39 Re: DCF based projections Wed Sep 18, 2013 11:59 pm

Academic

Senior Manager - Equity Analytics

Posts : 454
Equity Stars : 5633
Reputation : 103
Join date : 2011-01-23

As explained by others dividend has conflicting effects on market price.

Since P=D*(1+g)/(r-g)

Here market segmentation theory comes. There are investors invest in CTC to get dividend (may be relatively few) and others for price appreciation. If former was the majority, stopping dividend is negative in short run.

hunter wrote:

smallville wrote:How much a company earns for a share we buy is so worth than many things ;)Either they giv it a dividend or make new investment thru it..

That's obvious in theory.

But in reality, it seems, dividend acts as a measure of 'investor friendliness' and thus a booster in market price.

Suppose, NEST or CTC maintained same earnings but stopped dividend payouts. Would it affect market price positively or negatively?
Suppose RENU started giving handy dividends..?

hunter · 40 Re: DCF based projections Thu Sep 19, 2013 3:27 pm

hunter

Moderator

Posts : 786
Equity Stars : 7131
Reputation : 114
Join date : 2011-04-27

I worked out a longer introduction with some examples and put in a separate post. The link is below;

http://forum.srilankaequity.com/t30808-graphical-view-of-share-value-investing-in-cse-vs-saving-in-fixed-deposit

Jiggysaurus & Academic, Thanks a lot for your views.