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Aryan M

@ary
2 years ago ~670 views
When it comes to valuations under DCF as taught in multiple places, a practice I disagree is the way the terminal value is calculated

Now terminal value impacts a good chunk of the final value so it’s important to ensure the logic behind it makes sense

Terminal value is generally taught to be estimated using an arthimatic progression formula

FCF * (1+g) / (R-g) where R is the required return and g is the long term growth rate

Here’s what I disagree with (I could be totally wrong and it’s just an opinion):

Predicting revenue / profits / FCF at 10-20% for 3/5/10 years and then it suddenly dropping to the long term terminal rate for perpetuity close to 5%

Following this is half the reason why most companies seem “overvalued” when done this way

And where common sense to be foregone for a “methodology”

(1/n)
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Aryan M

@ary
2 years ago ~20 views
So here’s what I do:

The terminal value is essentialy the value of the firm at that particular point of time in the future

FCFF: EV, FCFE: Market cap

Rather than using the arthimatic progression formula to come up with a multiple (the formula is essentialy a justified multiple on the FCFF)

Which in most cases if taken at a required return of 15% and a terminal growth of 5% would be 10x (assuming beta is 1)

So instead I use my own multiple to find the EV / Market cap that would exist at the point

Now this can be based either on the multiple over the FCFF/FFFE or a metric like EV/EBITDA or P/e which I think would exist at the point and calculate the EV/ Mcap at that point

This also encompasses possible of re ratings, sensivity analysis is basically the range of exit multiples I can expect

(2/n)
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Aryan M

@ary
2 years ago ~40 views
The idea behind this is

The logic of a DCF is to see the investors cashflow

FCF is what i am entitled to as the owner

The terminal value would be the value the company would be worth which is basically the price I can sell it at that point

Most exits happen on a multiple, the multiple also is a good encompassment of the sentiment

If I’m predicting only 3 years and the company seems to be on a high growth path of 25% and currently trades at a 15x multiple

It’s not unfair for me to think in future it could trade at 20x PE and use that as a terminal rate and discount the stock

While also using scenarios to see it’s value it continues to trade at 15x or starts to trade at 10

Which in my head makes more sense than estimating it based on a terminal growth rate which wouldn’t be how the company would continue to grow at in 3 years

Open to comments, views and constructive criticisms, would love to hear the thoughts

(3/n)
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