Flexibility of Valuation Methods in ER?

proteus_1's picture
Rank: Monkey | 38

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?

Comments (8)

Aug 15, 2019

proteus_1, way too quiet in here. What about these resources:

  • Major Valuation Methods WACC in my Debt free model. Discounted Cash Flow Analysis A Discounted Cash Flow or DCF is one of the ... Valuations Income Approach- DCF Method + All discounted Cash and Earnings models, including debt assumptions ... valuation should be low
  • DCF with Negative Free Cash Flow does need to be included in the sum of the discounted cash flows. Having a few years of negative cash ... FCF in the future(in line with equity research reports I read on the firm). My question is that when ... positive cash flows it generates. Please correct me if I am wrong
  • Valuation under Discounted cash flow I am little confused on DCF Valuation. I did a valuation of a cash inflow for 2 years and terminal ... value cash flow at the end of 2nd year. I arrived at "x" value. Now by just increasing ... forecast period how can we increase value of organisation. The increase in value is equal to PV of
  • Discounted cash flow (DCF) has a great amount of cash, the DCF method ignore such fact and in my opinion get lower company value ... Hello everybody, I cannot understand 2 questions so far in DCF valuation: 1) Why cash which is ... than it should be. In my opinion, we should add outstanding cash to discounted FFCF
  • DCF Valuation Method a better understanding of what an intern would do at a BB relating to valuation models. Thanks. cash flow ... I have learned the rough steps of how to do a DCF analysis, but understand that prof. Damodaran ... teachers at their fingertips. Just curious to know why its so important to know the details of DCF ...
  • Stock Valuation: Why does DCF give us equity value close to the range of the current share price? Hi, I am finding it difficult to understand how DCF gives us the equity value in the range of the ... PV of future cash flows? Let's say you start a business with only equity, then balance sheet ... a value in the range of say $90-120? I am not able to understand it mathematically why the stock price is ...
  • Biotech finance part 2: valuation methodologies and modeling considerations a large role in valuation. Traditional methods of calculating discount rates like CAPM don't really ... expected value of their cash flows. In the last five years pharma companies have shown extraordinary ... willingness to pay up for strategic assets. If you look at models in equity research
  • More suggestions...

You're welcome.

Aug 26, 2019

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.

Sep 11, 2019

Ah ok, thanks for clarifying that for me!

Most Helpful
Aug 27, 2019

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.

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Sep 11, 2019

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?

Aug 29, 2019

We just use a multiple. We are setting a 12 month price target and not claiming to show intrinsic value.

Sep 11, 2019

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?

Sep 11, 2019
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