Flexibility of Valuation Methods in ER?
I skimmed an ER report from Bank of America today on Beyond Meat (BYND) and I saw that, whatever the assumptions regarding revenue, etc., in order to get a price target marginally above the (then) current market price, the analyst used a terminal growth of 5%, which would be a bit on the high side under normal circumstances, but given that there are serious recession concerns in the near future, the idea of 5% growth forever seems kind of out there. Additionally, the analyst forecasts sales out to FY2029 based on assumptions that seem ridiculous because there are SO MANY potential variables for a high growth company over the next 10 years. My question, as a prospective ER associate, is: is it convention for ER analysts to use a DCF to justify their valuations for EVERY stock they cover even if it really makes no sense to do so? And with that in mind, is it acceptable to use an exit multiple approach instead of terminal growth, since that seems a bit more logical, or is this not really done in ER?
Since it seems like you are specifically inquiring about sell side valuation methods, it has been my experience that most analysts will just slap a multiple on, and that not many are doing a DCF. I guess BYND and other companies that don't make money on an accounting earnings basis are a little different and you will see DCF's used more often here, but for the vast majority of the reports that I come across it is usually just a multiple based on either comps or their own historical trading range. Keep in mind that this is truly lazy analysis, as a multiple is in reality a function of profitability, the discount rate, and growth rate. So to look at a different company and say it should trade at that multiple ignores the differences in risk, profitability, and growth between the two. In the same vein, to take a historical multiple for the company and say that this is where something should trade also ignores changes in growth expectations, profitability, and risk over time. That said, on the sell side I feel that it is much easier to be wrong with the group than wrong against it, so I cannot blame analysts for doing it this way. When I first started out I did the same thing because I thought this is just what everyone does and it's easy to dismiss a DCF with "oh you can play the numbers to make the model say whatever you want", but today I almost exclusively use DCF's as my primary valuation tool, and I will look at multiples as more of a sanity check. The reason I prefer the DCF is it allows me to embed either a level of conservatism or aggression depending on my conviction around a name, and when coupled with some scenario analysis, it truly allows you to forecast a range of values rather than an precise target, which I believe is how valuation should be done. It also gives me a much better handle on downside and upside and what has to happen for either to play out.