Free Cash Flow as Value Criterion Message Board

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Strategies & Market Trends : Free Cash Flow as Value Criterion

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To: Andrew who wrote (23)	10/27/1997 8:18:00 PM
From: Pirah Naman	Read Replies (3) of 253

Andrew, your latest post reminds me of one more of my random thoughts. This is something I learned after I read the Parks book. What Buffett essentially does is to apply the Modigliani-Miller Dividend Irrelevancy Theorem to the Gordon Dividend Valuation Model. (As are you, currently.) The problem I found when playing with this formula is that almost all stocks can be found to be undervalued, even with very conservative estimates. As an example, a company expected to grow at 5% indefinitely with the discount rate of 9%, is worth 25x the next year's FCF. A company that doesn't grow at all, with the discount rate set at 9%, is worth 11x! I think Buffett's success is more due to his qualitative judgement than his quantitative modeling. This is why I prefer a very short, simple approach using the VL numbers. They project for four years out, and so I compare on the basis of FCF summed over the four years. Either approach is crystal ball gazing, I just think that given the nature of the math, a shorter period may be less subject to a cloudy crystal ball. :-) Pirah

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