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Strategies & Market Trends : Free Cash Flow as Value Criterion -- Ignore unavailable to you. Want to Upgrade?

To: Pirah Naman who wrote (24)	10/27/1997 8:56:00 PM
From: Andrew	Respond to of 253

Pirah, "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!" First of all, I'm glad that my math agrees with yours! If I hadn't got the same results, I'd be worried... I agree that the "indefinately" thing does represent a problem. I alluded to this in my first post, where I suggested using 10 or 20 years instead (after the first 10). If you checked my math, you may have noticed that in my last post, I still was working with indefinately - not conservative! The farther out you try to predict, the less you should depend on the results. Maybe we could incorporate as a variable the length of time we feel safe counting on. For stronger companies, 30 years may not be a long time. For smaller companies maybe 5 or 10 is a better way to go. Then again, a company that throws back the same amount of cash each year for a long time is certainly a worthwhile investment if you pay the right price. Whether that multiple turns out to be 11x or 5x is irrelevent to me. What matters is how certain that future cash is! When Buffett bought into Coke in 1988, he apparently felt it was quite reasonable to assume that Coke would be kicking back oodles of cash 30 or more years from now. I'm sure he wouldn't try to make the same assumption with Yahoo!. So my point is, cash that is coming to you has a real value that can be calculated - and that may give rise to "high" sounding multiples. Your valid counterpoint is "should we count on that cash in the first place?" I think you're right, and that's something I've been meaning to correct in my existing spreadsheets. I'll go back and redo my valuations on those 4 stocks using 10 years and 10 years. Then we can see if I really still consider them bargains under more conservative assumptions. Could you explain your VL method? That's what we're here for! To pick apart each other's technique, and learn from it. (If it's described in that link you posted, just tell me - I'm going to check it out soon!) One fundamental issue I have is this. The whole reason that I beleive in FCF valuation is that I beleive it is the fuel for the growth of long term intrinsic value. Perhaps the biggest leap of faith is that this FCF actually ends up in our pockets one way or another. I think I've made plenty of good arguments that this is the case when shareholder-oriented management is working for you. But this is fundamentally a SLOW process. I don't think you can predict where a stock's going to go within say 12 months based on it's FCF. It's not a short term catalyst. Where my faith is that in the long term, having strong and growing FCF will help push the company to higher per share earnings and sales that will make Wall Streeters want to pay more for a company regardless of what they think of FCF. So I'd like to hear your argument of how you translate say 4 years of FCF into a rational valuation. (I don't mean that to sound obnoxious, I'm genuinely interested!) Thanks for the reality check, Andrew

To: Pirah Naman who wrote (24)	10/27/1997 9:24:00 PM
From: Andrew	Respond to of 253

Ok, here are my numbers if you assume strong growth for 10 years, then slow growth for 10 years: INTC: Conservative: Strong:10%, Slow: 7% Value: $60 Optimistic: Strong:15%, Slow 9% Value: $87 Quote: $75 COHR: Conservative: Strong:10%, Slow: 7% Value: $37 Optimistic: Strong:15%, Slow 9% Value: $54 Quote: $37 UTR: Conservative: Strong:10%, Slow: 7% Value: $16 Optimistic: Strong:15%, Slow 9% Value: $23 Quote: $24 MCD Conservative: Strong:20%, Slow: 7% Value: $47 Optimistic: Strong:25%, Slow 9% Value: $70 Quote: $44 Ok, the picture this paints is less attractive. Is it more accurate? Are estimates of free cash flow beyond twenty years from now essentially valueless? That certainly sounds more conservative. Maybe we should go further, and only count the next few years of FCF as having value. But isn't that equally a distortion of reality? Certainly the distant future is very murky. But by buying and holding a stock for the long term, aren't we essentially saying that we already believe that this company will continue to be strong and successful many years from now? And if this company is assumed to be both, isn't it worthwhile to see what we'll get if we're right? If we're wrong, and the company performs poorly, the investment will turn out poorly. So buying implies uncertainty, but confidence. Essentially, we're already counting on those distant earnings to be there. So how much are they worth in today's dollars? Comments? Andrew