Pirah, thanks for the response...
"> I have not heard of his quick test you describe. It does sound like > an absolute valuation. Could you describe the math for me?
Sure. By the way, one of the very first examples in the Hagstrom book
illustrates this. Take the FCF (can't recall whether he used previous year or coming year) and divide by the current long bond yield to get the intrinsic value. If the price of the stock is below that figure then on this criterion the stock is a buy. In math terms:
If Price < FCF/LBY, then buy, or alternatively:
If 100*FCF/Price > LBY, then buy. Note that this puts the FCF in terms of a yield for direct comparison to a bond.
Again, the idea is that since the company's FCF "coupon" will grow, whereas a bond's remains constant, then if the company is giving a bigger coupon than the bond now, it will for the forseeable future."
Guess I forgot about that example in Hagstrom's book...thanks.
"> I am sure that when you decided (if you did) to buy Compaq, you made > some implicit assumptions about minimum growth.
Not really. My assumption was that the VL analyst, after working with the people at CPQ, had as good a handle as any on CPQ's prospects for the next year or few. At the time the LBY was around 6.6%. Based on VL projections, CPQ would have a 1997 FCF "yield" of 7.8%. Over the next 3-5 years, it would have a FCF "yield" of 8.7%. OK? Absolute value."
I agree that this is an "absolute" valuation, but it definately assumes a minimum growth rate! That yield calculation assumes zero growth in cash flow forever. I get the exact same answer using my formulas just by entering zero for the growth rate! We're doing the same thing! Just coming at it from different angles. I think you should recognize that your method does indeed make assumptions about long term FCF's. But our methodology is identical. So I don't think we even have any real philosophical differences here. Given the same input variables such as growth rate and discount rate, we will come up with the same valuations.
Andrew |
