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?
proteus_1, way too quiet in here. What about these resources:
You're welcome.
Also interested but more on things that deviate from traditional DCF valuation such as Monte Carlo simulation. To answer OP's question, yes, I've seen a bunch of sell side reports using multiples for terminal value calculation.
Ah ok, thanks for clarifying that for me!
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.
I agree in the sense that the DCF assumptions can be a double edged sword, but it is a very flexible tool (though maybe not ideal for all companies), and since stock prices are really a reflection of anticipated future growth, the nice thing is that ultimately, in the long run if you make correct assumptions, you'll probably have a good chance at understanding the prospects for the stock price. There is also something that is appealing to me at a more philosophical level about DCFs, though I do see value in using it in combination with comps/multiples. But I guess that is my issue with this very brief exposure to sell-side reports--what is the use of an assumption-drive model if you know the assumptions you are making are totally unrealistic and very unlikely ever to materialize?
We just use a multiple. We are setting a 12 month price target and not claiming to show intrinsic value.
I guess that that makes sense in response to my questioning the assumption of a 5% terminal value, but how can an estimate of where a stock will trade 12 months in the future be based on such shallow analysis. And to my original point, what is the point of using valuation methods that require ridiculous assumptions in order to get a 12 month price target? Wouldn't a DCF with an exit multiple or maybe even a revenue projection with an exit multiple make more sense than a DCF with a terminal value if the goal is to show where the stock might trade in the medium-term and not to describe intrinsic value? Just spit-balling here, but what's the point of producing such a worthless valuation analysis that doesn't really seem practically useful to anyone? It kind of appears that the analyst wanted the conclusion that the price would go up and just changed all the assumptions to make it happen, but is that common on the sell-side? I know it's the stereotype, but is it also the reality?
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