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Strategies & Market Trends : Graham and Doddsville -- Value Investing In The New Era -- Ignore unavailable to you. Want to Upgrade?

To: Reginald Middleton who wrote (234)	4/22/1998 10:56:00 PM
From: Freedom Fighter	Read Replies (2) \| Respond to of 1722

Reginald, You seem to be very familiar with CAPM and related subjects. I have studied two valuation books on the subject. Valuation - Mckinsey & Co Investment Valuation - Aswath Damodaran I have also purchased the spread sheet model from the former. I have developed a model that is similar, but has some personal modifications. Here are some thoughts and concerns I have. 1. I do not like beta or any similar item as a measurement of business risk. It may be measuring some kind of risk (market) and it may even be correlated to business risk, but there are examples in actual practice where I think it is way off the mark. I make subjective judgements based on history and my view of the present and future business risks instead. 2. The cost of equity is measured differently by different practitioners. Some use Govt. T-Bills, some use 30 Govt. Bonds, some use +3.5%, some use +5.5%. There does not seem to be a standard. 3. Some of the ideas about the capital structure also seem very hazy. The cost of capital is cheaper for bonds certainly, but as you increase debt and Return on Equity you also increase risk. There are some guidelines as to how to handle these capital structure issues, but it is also very hazy. 4. The terminal or residual portion of the value is of greater importance to the ultimate calculated value than the first 5 years. I do not think it is a safe bet that most companies will be around for the time required to approximate the value the model produces. Many certainly but, I suspect not most. This can produce some very speculative and I feel inaccurate results. 5. Small changes in the terminal growth rate assumptions, like will it be 5% or 6% or 6.5% can produce dramatically different conclusions. Let's face it noone knows these things. So while I agree with the model on an intellectual basis and use as much of it as I can (especially free cash calculations etc..) I believe it is flawed in practice even though it is used by most. I step through some of the calculations often just so I can get an idea of what Wall St. might be thinking. Not necessarily because I agree with the values it produces. I have spoken to many financial types who agree with my point of view. I know Buffet does not hold it in high regard either. At least he has made comments to that effect. Any thoughts?