Silicon Investor (SI) -- The First Internet Community

STOCKTALK

We've detected that you're using an ad content blocking browser plug-in or feature. Ads provide a critical source of revenue to the continued operation of Silicon Investor. We ask that you disable ad blocking while on Silicon Investor in the best interests of our community. If you are not using an ad blocker but are still receiving this message, make sure your browser's tracking protection is set to the 'standard' level.

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

To: Pirah Naman who wrote (88)	11/2/1997 3:40:00 AM
From: Andrew	Read Replies (1) \| Respond to of 253

Pirah, let me explain why I said you are making long term growth assumptions. Here's the first equation you gave me: Value = FCF/LBY This equation states that the present intrinsic value of a share is the value of an infinite series of equal future FCF's, discounted back to the present by the long bond yield. (I know you already know this, I'm just stating it for completeness). This calculation therefore assumes a long term growth rate of 0%. If it assumed growth (lower than LBY rate) of G, you would have Value=FCF/(LBY-G) which would make the value bigger. The next equation is just the above rearranged: "Yield" = FCF/Price 100% When this yield is bigger than the Long Bond rate, it's a buy. For CPQ you got 7.8% for 97, with LBY = 6.6%. Then you looked farther out, and saw that the yield further improved to 8.7%, because FCF will likely be even higher. So it looks like you're only making assumptions about a few short years, right? But this is mathematically the same as saying "I want a yield of say 7.8%, so what price should I pay". You would calculate that using the first equation, substituting your desired yield as the discount rate instead of the LBY. The math is identical. And that math depends on the assumption of infinite equal FCF's. You're not just assuming that 97 will show FCF of $X. You're implicitly assuming that every year after 97 will also show FCF of (at least) $X. You may be planning to only HOLD for a few years, but your VALUATION depends on assumptions about perpetuity. You are essentially saying "if CPQ has at least the same FCF (as 97) every year forever, it's worth X. I'll be OK if I pay less than X." I'm certainly not criticizing your method here! Because it involves the exact same assumptions that mine does. You just happen to be choosing 0% (nice and conservative) as your growth rate, and using discount rates higher than the LBY. As I said before, by putting 0% in my formula, and picking discount rates higher than the LBY, I get the same "answers" as you. Therefore, you are also "arguing for using the Gordon Dividend valuation method with the application of the Miller-Modigliani Dividend Irrelevancy Theorem."* Your valuation method as described could not possibly be "more selective" than mine, because it's the same method. Andrew