Joan and Pirah,
Chimera? Illusory? Vocabulary? <g>
I'm with you guys on that exactitude thing. I just want to establish some approximate bounds on absolute (I mean "real" here) as opposed to relative value. I don't think that requires exactitude. Just "good" minimum (not worst worst case of course) estimates and a way to decide what they're worth. As we have agreed, the results are only as certain as your estimates, which means not very.
But if that non-growing company does keep slamming out the same cash every year, and you are happy with a 9% return, I think it is worth 11x to you. Because then it's a bond. If you're wrong, it won't because of your valuation, it'll because of your analysis on prospects and all that. Therefore I propose that "the math is right, but you'll
only get the right output if you give the right inputs".
Analysis on prospects and all that is the most important part of picking stocks anyway. When you buy stocks, you are making bets that the underlying companies will grow over the long term. If they grow a lot, you figure you'll make a nice amount of money. If they grow only a little, you probably make less. But if the price you pay doesn't make sense economically - that is you paid more than you could get back even if your analysis was right, you could do very poorly. So you have to be able to successfully:
1. Correctly pick a company with a bright future.
2. Not pay too much for that bright future.
How about you make some guesses in your head on how much FCF you would consider good enough for that future to be considered "bright". Since you like this company's chances, and you want to buy the stock, you probably feel that the company's FCF is going to increase somewhat. So let's take a minimum growth rate of 10% a year on average. That's not unreasonble for a company with a bright future. And this great company is probably going to be around at least 10-20 years - that's why you want to buy the stock right? So why not use the formula (which we know correctly discounts future cash to the present) to establish a minimum value for a company (with a bright future) to an investor (who wants to make at least x% a year). As long as you buy the stock below that minimum value, you only have to worry about successfully:
1. Correctly picking a company with a bright future.
What I'm saying is, whenever you buy a stock for the long term, you are implicitly making "long-term predictions" anyway. So why not put 'em down on paper, plug'em into the ol' spreadsheet, and see what a good approximate maximum price is? No exactitude required, just a rough guess.
That way, you don't have to worry about short or medium term changes in market psychology. You just have to keep checking that the "bright future" remains intact.
Andrew |
