A Reader’s Question on DCF




QUESTION:  So the intrinsic value of a company is the present value of all future cash flows?

Now everyone has a different required rate of return or discount rate, so does that mean one person’s intrinsic value of a business will be different from another person (not because of different estimates of future cash flows but because of discount rate)?

CSInvesting: Yes, a pension fund may be fine with a discount rate of 8.5% but you require 15%.

I just want to confirm what it means when in articles, famous investors talk about their investments and they would say for example that they found a business which they think is worth $50 but was trading at $15. Is their estimate of $50 the value they came up with after using their own discount rate, or is it more a comparable analysis of using a discount rate of the industry norm and that’s the value that they come up with.

I don’t know what discount rate they are using, but when you see a company trading at $15 and you think it is worth, then probably your valuation is off.   Markets are not ALWAYS inefficient, but they are usually not GROSSLY inefficient.  Say, you value a miner based on today’s gold price of $1,200 and it trades at triple the price in two years but the gold price trades at $1,600 (US) then a speculative element changed your valuation.


I ask because some say they will buy only if there is a 50% discount to their intrinsic value and would sell around 90-100% of their intrinsic value.  But say for example that you used a discount rate of 20% to get your intrinsic value and it so happens to be selling at 50% discount and you bought it.  Even if price reached 100% of such intrinsic value, basically what that means is going forward for that price, you will be getting 20% returns for holding that investment, which to me is an excellent investment and would hold on and not sell (assuming that the cashflow is certain for the example).


I think you are double counting.   You use 20% discount rate when usually the cost of equity capital is 7% to 11% AND it trades at a 50% discount, then your valuation is probably in fantasy land.

Some go to Prof. Damodaran’s Industry Cost of Capital Spreadsheet


http://people.stern.nyu.edu/adamodar/New_Home_Page/datafile/wacc.htm  But I wouldn’t use it other than to see what most analysts use.
REMEMBER the iron law of CSInvesting.  If you know or do something that everyone else does in the market, then it is probably useless.




Chapter 8 Cost-of-Equity-Capital Credit Model by Hackel 

The analysis of risk represents the single most underexplored factor in security research and the primary reason for investor disappointment in their investment returns.

The cost of equity capital, while known as a measure of investors’ attitudes toward risk, more aptly should represent the uncertainty to the cash flows investors can expect to receive from their investment in the security being considered.  Only through n accurate and reliable cost of equity capital can fair value be established as well as the determination of whether management is creating value for shareholders, as measured by the return on invested capital (ROIC) in comparison with its cost.

Because security analysts are not confronted with the daily barrage of problems and hazards that managers and executives working directly for the entity face a wide swath of hidden risks that tends to be ignored or not calibrated properly. Investors need to think and behave like corporate insiders to truly appreciate this multitude of exposures so as to accurately place a cost of capital that takes into account these uncertainties, of which any one could damper cash flows or even threaten the entity’s survival.  On the other hand, if investors were to overweigh such risks, the entity’s valuation multiple would depress, causing misevaluation.

Say the standard tech company has a cost of capital of 9%.  Well, Apple’s might have a lower, 7.6% cost of equity capital, because of the lower operational risk of its business as noted by the cost of its credit.

Use a credit model for the cost of equity capital –See ch. 8: Security Valuation and Risk Analysis by Kenneth Hackel. (in Value Vault)

At least you are garnering a different perspective.    Good questions.

4 responses to “A Reader’s Question on DCF

  1. Steven Malcmacher

    Sorry, I don’t get the whole conversation. What future cash flows are worth depends solely on what return you would be satisfied with. Why anyone would use any other discount rate is beside me. Yet to hear a rational, sensible reason why there should be more to the discussion that this. Would love to hear one, as there are plenty of good investors who engage in the above logic.

  2. Hi Steven,

    That is what I am thinking as well. Some maybe satisfied with a lower return than others, so everyone’s required rate is different.

    The main question I was trying to ask is trying to figure out what is meant by intrinsic value when people talk about it – not the philosophy behind it but the actual dollar figure. For example, Buffett said that PetroChina was worth $100B when it was trading at $35B. So the $100B figure here, is that the figure he came up with using his own discount rate, or is it using the industry WACC?

  3. Was thinking if you could provide an example on DCF or NPV calculation of gold mining industry. I am a shareholder of a junior miner and trying to see if my idea of it being undervalued holds true. The stock is TGD: Timmins Gold. The things is this miner has one positive cash generating mine and another project.

    • Why don’t YOU do it. You will learn more.

      I will email you background on how to do a NPV for a miner.

      Take TGD’s financials

Leave a Reply

Your email address will not be published. Required fields are marked *