DCF is it worth it

No worried. It was easy enough to find int his case but sometimes they aren't.

Doing a DCF is a reality check for potential outcomes. I often will do a bullish outcome, average and then a bearish then see if the price point still makes sense.

It depends on the asset you're looking at. The point of a DCF is not to provide some capital T truth on asset value, but to illuminate what factors need to be true in order to make an asset compelling value.

Valuations exist on a spectrum:

More objective / cash-flow anchored More speculative / assumption-driven

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DCF more useful <-------------------------------------------------------------------------------------------

\-------------------------------------------------------------> Speculation / narrative dependence increases

If you're looking at a growth/speculative stock, a DCF is not going to help you. A lot of people here seem to have rigid valuation beliefs: they take value-stock frameworks and try to force them onto growth and speculative assets. That is a category error. If you don’t want to pay a premium for growth, or you don’t want to speculate, that’s completely fair. But the stock does not care about your framework. Not all assets behave like mature value stocks, and they don't fall to reality on any schedule. Far more important in determining the value of these assets are: central bank driven liquidity, retail/social attention, investor sentiment, narrative.

I’m close to your view here. A DCF can be useful, but only after you understand the business. Otherwise it’s just a spreadsheet version of a guess. My first filter would be much more boring: understand what the company does, check whether cash flow is real, debt is manageable, margins are stable, dilution isn’t ugly, and the 10-K / 10-Q doesn’t show obvious red flags. If it survives that, then a DCF can help frame what the market is assuming. But I wouldn’t use it as the first step. Most weak ideas should probably die before the model.

Probably I do not do it 100% right, but for stalwarts with a static business model you can use DCF but a simpler method is to estimate the long term total returns based on dividend yield plus dividend growth, and then divide that by the cost of equity to come up with a rough appraisal of value. The hard part here is estimating future growth and for that I would always use the average ROE x Plowback or average historical growth and take the lower of approach or just try to close the gap.

For companies like MSFT engaging in massive CAPEX, changing their business model, I generally take the “don’t have a clue” approach unless I do have a clue. For those kind of businesses I have the index to fall back on.

For startups in existing industries, DCF is probably the most rigorous method but I find it easier to just estimate revenue in 3-5 years and then use industry P/S to get a rough idea of value, if I think they can hit those industry margins and then discount back the exit price.

I just look for no brainers, if I need to resort to a spreadsheet, I generally assume it’s not a no brainer and move on.

I don’t use DCF to “value” a company per se. I use it more as a mathematical framework to figure out

1. What the market is assuming right now
2. What needs to happen for me a to get returns above my hurdle rate

And then use my actual knowledge of the business to work through those numbers.

What is an FCF?

Well dipshit, quit complaining about it. Those that don't know should start by research.

I think a DCF is absolutely required, as long as you truly understand what goes into it with the caveat that, as others have said, trash in = trash out.

To be clear, I think what you wrote about understanding the company and really going in deep is required. Honestly, I think that is required before doing a full DCF. They go hand in hand. This is basically my workflow:

1. Something peaks my interest. Either a sector or industry I think I might want to allocate to, something pops up in the news, I read something on reddit, or something stands out to me in my regular screening of the markets.

1. Depending on what drew my attention I start looking deeper. If it was a particular industry or sector, and I'm not already familiar with it. That's where I start. If it was a particular company, I might start there and go outwards to competitors, industry, etc.

1. At some point I get to the specific company I'm looking at (either earlier or sooner, whichever workflow I took from 1 and 2 above), and there are a few things I look at for what I call the "2-minute drill". If it doesn't pass my non-negotiables based on my rules and their fundamentals, I'm already done.

One note: My default for any given potential investment is a "no". Most people start with a default of "yes" and look for reasons NOT to buy the company. I start with a default of "no", and I force the company to change my mind. Sounds trivial, but it helps.

1. If they pass #3, then I'll do a deep dive. Past filings, past earnings presentations, management interviews (typically you'll only find the CEO, but you never know), analyst commentary (I put less weight into these, but they sometimes mention things I never thought about), and so on.

1. At this stage I have either ruled it out or think that there could be something here. The next step is to get a feel for valuation, what the company might do in the future given different scenarios, and what sort of margin for safety I need to invest.

Note: This is where all of the work you did prior to this comes into play. At this point you have done significant research, understand the company, markets, competitors, risks, and so on. THIS is what you use to come up with a range of possibilities for your DCF. This is the info you use to adjust your DCF up and down to stress test the thesis.

I start with the standard, academic version of the simple DCF taught in school. I don't mess with the whole "break the company down into their individual lines of business, calculate a levered and unlevered beta for each of them, calculate a WACC for each of them, and aggregate them up to the parent company".... that is just too much for what we need, and frankly that is just Finance PhDs with too much time on their hands. I have never seen proof that it is useful.

Anyways, with that standard DCF as the base case I use my understanding of the business, management, market, competitors, etc. to adjust my DCF for a worst case scenario, and a PLAUSIBLE best case scenario that is lofty, but also makes sense and is realistic.

Personally, this isn't to tell me if the company is undervalued or over-valued. For me, this is mostly psychological. It gives me confidence that I did my due-diligence, AND it gives me strength to hold on drawdowns instead of panic selling.

It isn't perfect. Yes it is a guess. But it is an educated guess, and it is what the entire financial industry is built on.

If the criticism is it's inaccurate, id argue it's supposed to be.. inaccurately unfair to the company, but grounded in the minimalist of true facts.

So you don't take a 6b fcf a year and say next year it collapses to 2 with zero evidence, but you don't take their 6 percent growth guidance, you give maybe 3. You assume a one time margin hit lasts twice as long. Your terminal value is the most modest of growths.

Then after beating the hell up the company is still undervalued as f, you buy. Most companies will never meet this cheaper than dirt framework...

But who cares, my goal isn't to properly value Microsoft. It's to get a dollars for quarters.