Nah man, it’s not at all about criticizing ( I like your model and thanks again for sending it), it’s really about having a discussion.
Ok, I’ll do my questions one by one ( no need to make a boring-ass list) :
Hmmm, good question. First, it’s the way I learned so I stick with it. Secondly, FCF is just that, free cash that can be used for reinvestments in the business, dividends, or skimmed into my bank account. Those forecasted free cash flows can then be discounted to a present value which is hard dollars. Everything else has been stripped out of the profit but the raw dollars.
I once read a seekingalpha report that went something along the lines of “I feel forecasting net income is a better method for finding value in this stock…” Hacksaw.
Net income is only a number. Cash is king.
I am not discussinf the use of FCF, I am simply debating the formula to get to FCF.
Wouldn’t [CFO - Capex] be a better approach ?
I mean the NOPAT method does not take into account change in some none cash items…
The CFO - Capex, on the other hand, takes into account everything…
^ This is news to me. Can you explain some more?
Well I mean that the NOPAT method (which I admit is widely used, btw.) starts at EBIT, and does not eliminate non-cash items from the Income Statement (which have an EBIT effect).
On the other hand, the non-cash items are always eliminated on the CF Statement to arrive at CFO.
Therefore, my statement is that [CFO - Capex] gives a better definition of FCF.
haven’t seen the model, but I just went thru this in the L2 curriculum
if you’re trying to get FCF from the NOPAT you need to add changes in deferred taxes, addback D&A (net noncash charges) and subtract capex along with increases in net working capital
ive got a question
how did you pick 10 yr treas. for your rfr? I’ve always matched rfr years with the years that the model is forecasting for. Is that not correct?
I just went on Yahoo Finance and typed in the 10 year treasury rate. I don’t know if that is correct or prudent, but it’s what I did since that is what I was taught.
sorry, i was unclear. How did you pick a 10 year maturity? I was taught for a valuation based ona 5 year forecast, that you would use a 5 year rfr
How long does it take to make one of these from scratch?
This one took about 30 hours. I’m probably slower than most though.
Thanks for sending, CFAvsMBA.
Respect.
Thanks for sending. CFAvsMBA.
Ok, enough on the FCF definition.
Here is my next remark / question, this time concerning your P/E valuation:
on your historical P/E valuation : you applied the last 3 years average historical P/E on current year forecasted earnings
on your comparable P/E valuation : you applied an average of comparable P/Es to next year budgeted earnings
–> Obviously both these P/E valuations are relevant ; now, what would you think about adding an additional P/E valuation, this time using a Schiller-ish component to it ? IMO one of the safest P/E method would be :
a) to divide the current P by the average of past EPS for each of the 3 comparables in your model, and make an average of these P/Es
b) to apply a) to your target’s current EPS.
What do you think ?
I like how you think. However, dividing current P by an average of prior Es is not a good metric in my opinion. EPS is just a number. It means little by itself unless accompanied by a stock price, dividend payout percentage, or ROE. I don’t think it would be wise to use an average of Es for the P/E ratio.
I’m not familiar with the Schillerish component you speak of.
As a whole, I’m a big believer in reversion to the mean. This is why I’m using both a time series and industry comparable to assess the current multiple by the target company.
Well, what I called the Shiller-ish component is just a little twist towards a Shiller P/E (beg your pardon, without “c”).
Why do you say that it wouldn’t be wise to you the past average EPS ?
If you think of EPS as the “product you are buying by buying the share” then you should prefer to know what you are buying in terms of “what has been the average product in the past” instead of “what was the product last time” or “what should be the product next time”. Earnings tend to fluctuate and why would you value a company based on just one data point when you can easily value it based on many ?
Just my view, but I always use FCF - Capex. NOPAT is also a viable method but I prefer quick back of the envelope calculations. For every model that takes you a day to build, you could have likely found a high probability mispricing somewhere else by using back of the envelope math. Remember kiddos, there are hundreds of mispriced stocks every day.
Average FCF and capex over a business cycle is generally a better proxy than any one year unless the business is very stable (which in and of itself deserves a higher multiple). I agree with Viceroy that looking at historic E and FCF averages is important, but you have to be careful taking a linear average.
All that said, I use EV/Sales and private market value more than any other metrics since those seem to be the most predictive in my experience. I’m not opposed to investing in companies with zero or even negative FCF or E depending on the circumstances. EV/S is even more predictive for shorts.