- David ModeratorNovember 26, 2018 at 2:09 pmPost count: 152
I don’t use any fancy formulas, I keep it simple.
If I’m picking stocks then I have two things to consider for the discount rate.
1. The long-term return of the market
2. The long-term inflation rate
I need to at least match the market and keep up with inflation when picking stocks, otherwise there is no sense in doing it.
Taking the S&P 500 as an example the long-term (Jan. 1st, 1871 – Dec. 31st, 2015) CAGR is 9.05% (Including dividends) and the long-term inflation rate (1913-2015) is 3.18%.
This gets me to a 12.23% discount rate.
No you might argue that one doesn’t need to include inflation since companies can pass the cost of inflation on to the customer.
If you are Coca-cola or Philip Morris then you can but most companies don’t have that kind of pricing power. For instance, a dollar store can’t pass the cost of inflation on to its customers since it has to keep selling inventory at a dollar (Terrible long-term business model!).
Most firms don’t have differentiated products/services, those that do have pricing power which stems from some kind of moat.
No moat, no pricing power.
That’s why I include inflation in the discount rate.
Hope this helps!
Davidmario123n@gmail.com NewbieNovember 26, 2018 at 5:15 pmPost count: 8
Regarding your answer to Jordan, does that mean when you pick stocks you are looking for something that will give you a better return than 12.23% either up front or shortly after?
Mario.David ModeratorNovember 27, 2018 at 2:36 pmPost count: 152
Yes, the aim to to find investments that return >12%.
DavidJORDAN Y NewbieNovember 28, 2018 at 2:11 amPost count: 2
Thanks for the reply David.
I find the challenging part is always what discount rate to use.
I was taught to use CAPM and WACC for DCF but I find that it is not so practical in real life. It is commonly used by analyst but i don’t think seasoned investors will use it. If I remember correctly, one of the TIP podcasts also mentioned that such methods are not so practical.
Do you have any thoughts on this ?David ModeratorNovember 30, 2018 at 3:59 pmPost count: 152
I don’t bother with CAPM or WACC, I simply take the long-term market return and inflation rate, add them together and that is my discount rate.
Another way to do it is to think of a stock more like a bond and value it that way. So take the current free cash flow and compare it to the current market cap to figure out a free cash flow yield.
Company XYZ has (ttm) FCF of $100 Mil and a market cap of $700 Mil
100/700 = 0.1428 (x 100 for percent)
So the Free cash flow yield is 14.28%
Then ask yourself;
Does this return beat the market return plus inflation?
Am I happy with this return or do I need more?
Is the FCF sustainable?
Will the FCF grow?
If FCF is lumpy due to the firm being a cyclical then you need to normailze free cash flow. What is average FCF across a business cycle, then use that figure.
DavidEmanuele Z MemberDecember 1, 2018 at 6:47 amPost count: 12
I would like to see analyzed a stock that you just put 15%+ of your portfolio on it…. 🙂Stig AdministratorDecember 1, 2018 at 9:39 amPost count: 162
I did that with BRK only. But that was a long ting ago. I like the current valuation too though 🙂
Price is what you pay. Value is what you get. - Warren BuffettAntoine NewbieDecember 2, 2018 at 5:32 pmPost count: 6
Would be interesting to value financial picks. Like JP Morgan or BoA since Berkshire recentlty added these to its portfolio.
Antoinemario123n@gmail.com NewbieDecember 6, 2018 at 1:04 amPost count: 8
Baupost, Appaloosa and Oaktree have been buying it recently.
Mario.Mr M NewbieDecember 15, 2018 at 8:34 amPost count: 1
Westrock, WRK – cardboard company, which is a pretty high volume, low profit margin industry. Their fundamentals look solid, and they’re improving efficiency of the business. Their main moat is size and price. Solid growth in sales and profit. Keeping debt under control. Their main competitor is International Paper, IP. Either company would be good to evaluate, because they are both priced similarly, with my opinion being that both are currently undervalued. I believe WRK will take market share away from IP, and that volumes will continue to increase as online shopping increases (and is less cardboard/packing materials efficient than buying things in stores). Boring product. Currently valued at ~44. I think it is worth ~70.
Cabot Microelectronics, CCMP – makes consummables related to IC manufacturing. They have had solid growth in their financials, and that growth appears sustainable, at least for the next 5-10 years. Given a linear regression of their financials and market cap against the rest of the market, I estimate that the market is valuing this company way below what they are valuing the rest of the market. Very boring product, and it is admittedly very focused. I think the demand is solid, they will take market share away from Dow chemicals, and will also increase in valuation to match the rest of the market. Currently valued at ~94. I’m estimating it is worth ~140, plus growth.
You must be logged in to reply to this topic.