DCFs no longer necessary?

I've been told by a couple of people (growth side, not value) that buyside analysts won't bother with DCFs anymore--instead they'll project revenue and earnings growth based on a variety of factors in a proprietary model. Is this commonplace?

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Sep 7, 2019

Sounds like a top.

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Sep 7, 2019

Not true. Some groups don't. Some groups do. I'd bet that the % that do correlated with how trough valuations are

Sep 9, 2019

Are you referring to the actual process of putting together DCFs or the broader implication that valuation doesn't matter anymore?

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Sep 10, 2019

I work at a value fund. Most people I know (myself included) just project out relevant financials, slap a multiple on whatever year you expect to exit the investment, and run a basic sensitivity. Practically, a DCF isn't useful because 1) high sensitivity to abstract inputs (growth to perpetuity, wacc, capm ,etc) 2) market value =/= implied value in the short to medium run 3) the same company can command a number of valuations at different times, even if DCF inputs have not changed. Maybe a DCF could be more applicable if a fund's holding period is more like 5+ years.

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Sep 13, 2019

I mean in this market what's the point of knowing how to do a dcf. When the value factor stocks can rally 25% in 2 weeks. Seems like the best thing to know is when the machine throw in their algo.

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Sep 13, 2019

To be fair momentum has been one of the most crowded trades in the last few years...

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Sep 15, 2019
Dunder:

I work at a value fund. Most people I know (myself included) just project out relevant financials, slap a multiple on whatever year you expect to exit the investment, and run a basic sensitivity. Practically, a DCF isn't useful because 1) high sensitivity to abstract inputs (growth to perpetuity, wacc, capm ,etc) 2) market value =/= implied value in the short to medium run 3) the same company can command a number of valuations at different times, even if DCF inputs have not changed. Maybe a DCF could be more applicable if a fund's holding period is more like 5+ years.

What? How is that any more "accurate"? You're still projecting earnings, which is inherently subject to error, and you're choosing a multiple which is no more arbitrary than a discount rate. (I hope you realize a multiple is essentially the inverse of WACC...) And if you're using EBITDA and not cash flow for your multiple that is way worse than a DCF.

It's fine to say you don't do DCFs because you don't think the incremental work adds value, but thinking you are somehow avoiding the inherent issues with a DCF by using a multiple is absurd.

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Sep 15, 2019

I generally stick to fcf and earnings multiples given all the lease accounting changes recently, makes things easier...

Yes the multiple is just shorthand for a dcf. Didn't say one or the other was more accurate. I just prefer multiples because you can quickly get the market value of something and do it in a way that is more predictable and intuitive. As an example, it more intuitive to say company A should trade more in line with peers at B multiple if x, y, and z occur vs why growth in perpetuity in a dcf should be 1.5% vs 1.8%. Also, multiples are a market derived metric. Unlike a dcf, I'm not penciling in what the discount rate should be. I have enough experience in my sector to know what characteristics deserve what multiples. So I can say if things play out like my thesis implies, this company should trade at x multiple.

To each their own here...investments are an inherently subjective business.

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Sep 16, 2019

This is absolutely my intuition. Makes total sense.

Sep 11, 2019

I am not into HF but can say that from my side (exotics/hybrids EQD) no one knows what a DCF is in either trading sales or quant

Sep 12, 2019

How does HF diligence process and valuation differ from a PE firm?

Sep 13, 2019

Valuation differs significantly due to liquidity. There's a pretty big delta in valuation with smaller companies but that starts to change as you get bigger & bigger.

Sep 13, 2019

It's not like making a DCF is hard/much incremental work, especially when you're already projecting out numbers.

Its a good incremental data point / sanity check - but not the end all be all.

Sep 15, 2019

Interesting. Im not convinced that's the case, would you have any evidence to believe so? At my AM shop (~450bn AuM) - as well as others. I don't see the Equities desks (or other asset/cross-asset) desks do that.. relationships with brokers and the sell-side ex: equity research and the use dynamic/static models such as DCF's is always going to be part of the package and useful for the buy-side for reasons of depth and valuable time - without mentioning the use of proprietary models. Even if you do reduce their utlity to say Long-only (which isnt true) that still represents a significant proportion of AuM out there.

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Sep 16, 2019

I don't get this whole discussion. I use a DCF two ways: assess "intrinsic" value (alongside owners earnings, cash, strategic value etc. etc.) and sometimes to backcheck what underlying assumptions would have change and by how much to justify an increase of X / intrinsic value, or a current market price or whatever. You can make return even without ever closing "a margin of safety".... I don't think investing just on DCF has ever worked, unless you own all the cash i.e. 100% of the business (and never divest...). I don't understand why forecasting earnings and using multiples as you mentioned is in anyway a replacement for a dcf? When you say: forecast earnings based on a proprietary model, how does that differ from a DCF? If I forecast something I can discount cash as well as I can just apply a multiple i.e. a DCF is also an implicit multiple method, so I don't get why they should be exclusive. If you mean: do buyside analysts have a DCF model as their core tool to invest? The answer is no and has never been yes in public markets, at least in my view. Your terminal year value is nothing but forecasting an operating model and slapping a multiple on it.... Its just much faster to say EBITDA in year 3 x 10.... I think the people you refer to mean that everything trades at premium to intrinsic value these days hence lets rather have comfort where the contraction is not severe and just extrapolate vs. really finding something that is really mispriced...

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Sep 16, 2019

IMO intrinsic value isn't very useful outside of an academic setting (could be many many years before market agrees with you on what intrinsic value should be). It really comes down to how much upside/downside you have in your numbers vs street or buy side expectations.

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Sep 17, 2019

Intrinsic value isn't useful? Knowing intrinsic value is extremely useful. However, I stated explicitly that intrinsic value and returns should be explored separately and you cant invest just based on intrinsic value. My whole point was that finding intrinsic value is a good tool (alongside others) to know your downside and where the market currently is etc. but that it is not nec. a tool used to screen for great return potential...

When you say how much upside / downside you have - based on what market pricing / multiple applied to your forecast? Wouldn't it make sense to at least know where market sentiment is vs. "theoretical" value even if you choose to ignore it then?
A margin of safety is not there to be closed necessarily but to give you a buffer against fuck ups, market sentiment changes and other things (because even if the gap doesn't close it cant really hurt, can it?).... Let see how crisis proof "It really comes down to how much upside/downside you have in your numbers vs street or buy side expectations" is, when the entire market re-rates.
Personally, I think intrinsic value doesn't have to be pure cash based. I use strategic takeout value (if i know it really there...) as something similar / an anchor point regardless of market valuation and sometimes other factors but you need some form of view on value in isolation...

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Sep 16, 2019

Eh not really AM / HF / S&T related but at my shop in CD / CS we have a prop model that we use. It still does a DCF off a based set of expense / revenue / capital options but I would argue it is somewhere in the middle of "automated" and "manual".

Mainly a function of most of our partnerships / acquisitions being more or less consistent in industry / operating model so it's not really worth it to rebuild ground up every time we want a model run.

Sep 20, 2019

We use DCFs as part of our analysis process, but it's not the end-all-be-all. Our models are verrry ad hoc, depending on the company we are analyzing, and we typically look to price consensus forecasts before making our own adjustments. I think this is pretty standard on the street.

Sep 23, 2019
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