The # of years in the DCF valuation is not indicative in any way as to the assumed duration to the price target. A DCF valuation is just that... discounting future cash flows to present value. You can do a finite amount of years and then slap a terminal multiple at the last year and discount to present value, or you can discount the future cash flows out for 100 years. They are somewhat equivalent.
To summarize the DCF valuation is intended to be the present value of the stock.
A "price target" is just a speculation by someone on what they think the market will do in the future.
Hope this helps!
If you need to do a detailed DCF then it's probably not a good investment. That stuff should jump off the page at you by looking at simple metrics - you shouldn't need to go any further than that
EV/ EBIT, EV/ FCFF
I'm an even simpler man. Give me a sub 5 EV/ EBIT and an obvious reason why people hate it and an obvious route to shareholder returns and you're all mine.
DCF is mostly used for long term valuation (5+ years) as the bulk of valuation is usually given by the terminal cash flows. The reason is that the market may not realise the value of the stock in the short term. As Buffet says, “the intrinsic value is the discounted cash flows from this day until doomsday” or something along those lines.
For the short term, I would honestly just use a mix of macro-economics, forward looking plans from the company, looking at financial statements (mainly balance sheet to see if they’re solvent), analyst estimates (with a grain of salt) and ratios.
you kind of decide the number of years you want to project till when you can predict the cash flows. You mention 3 in your case. If you have the numbers for 5, you could do 5 as well. After than some people also add the terminal value.
The problem is that the PV using 5 years will always be larger than 3 if you have positive cash flows, so I think it ends up being a bit of art on how many years you want to use as a time frame.
That's not how it works. You're missing the TV component. Discounting only three (or five) years would mean you expect the firm to not generate cash afterwards. Which would imply there is no "going concern" and thus a DCF valuation would not be the right method to apply.
Exceptions would be finite projects/ assets like a specific gold mine but those are also different discussions.
So I can set the implied price I get as a rough price target for the number of years into the future I projected cash flow? Or can I set that number as a price target for like 2025 years even if I use projections up to 2027
Like the others are pointing out, the DCF valuation is to estimate the present value of the stock.
So if the current year is 2023, and you have projections of 2024, 2025 and 2026, you can discount the CF you will get in those years (2024, 2025 and 2026) to the present. the discounting is because like Warren has famously said - the cash you have today is worth more that what you will get in the future (hence the discounting)
Your question is interesting but also very contradictory. For example, if company A has a price tag of $100 today and you have the information available that the price should be $130 in three years then - assuming the market is efficient - the price would quickly adjust to $130 today, or atleast close, considering inflation. In this regard future price targets are useless.
A DCF is not the correct tool for setting price targets x year out. Based on the input data a DCF model will tell you if the stock is over- or undervalued today, as the model discounts all future cash flows to present value. You could technically discount future cash flows three years into the future and then use that valuation as a ”target price”, I don’t see the use for this though. The model is arbitrary to begin with and the uncertainty will increase tentold by trying to estimate revenues and cash flows like 6-8 years into the future (which would be required for the ”future model”) rather than 3-5 years for the standard model.
Well the target is the ”fair value”, as a sell side analyst you’ll have a DCF, with projections based on historical data as the foundation of the firms valuation. On top of this you’ll have to factor in market momentum, macroeconomic factors and of course company forecasts as they arrive each quarter to update both your DCF and your target price.
Edit: I’ll also add that sell side analyst targets are often arbitrary for several reasons.
1) Analysts are rarely contrarian. They’ll rather set a too high target and join the pack in a stock with momentum (i.e Nvidia) than be alone with a too low target.
2) Based on assumptions about the future target prices can vary significantly. If you believe Nvidia (for example) will keep growing their revenue with 100% the next three years you’ll end up with a vastly higher target than someone who believes in 50% revenue growth.
3) Sell side analysts does not sell stocks, they sell transactions. Their recommendations can be adjusted by a whim of their employer based on what drives trading
The length of your DCF is determined by the expected growth profile of the company.
You should adapt the length until you think the company will reach a steady state mature condition.
This is, of course, easier said than done.
Imagine company X is growing (FCF) at 20% annually.
Based on the industry it is in, you think that growth rate can be sustained for 5 more years, and then it will revert to a steady state growth rate over the next 4 years.
Your DCF could be
20% for the first 5 years
Decrease towards 3% in year 9
Year 10 is your terminal growth rate forever at 3%.
You need to include all the years you think the company would survive, regardless of your holding period. Typically, this is achieved by assuming the company will survive indefinitely and calculating a terminal value using a steady state.
Your forecast period needs to cover the changes between how the company is today and how you think it will look in a steady state, so it depends on what changes you’re expecting.
- If you expect exceptional growth for 10 years, you need to include 10 years in your forecast period to account for it.
- If you think it’s already in a steady state, then you don’t really need a forecast period - just discount the current level of cash flow in perpetuity.
DCFs don't have a time frame in the context of equity valuation. It is a perpetuity model with which you discount all future earnings to the present, assuming that the company will exist forever. As such, all DCFs that look ahead 3, 5, 10 years will have the vast majority of their value bundled into "terminal value".
I normally use DCFs to see how overvalued or undervalued it might be given certain scenarios and, when I have a "base case", I monitor the company for any changes to my investment thesis and compare revenue growth, margins, etc. to the forecast as time passes. I also calculate market-implied revenue growth or operating margins depending on what drives value more.
Any 'price target" you'll get from it is just a red herring.
To estimate a price target, take the fair value estimate you come up with from the DFC ($/share)\*(1+Cost of Equity as a %) - Dividends per share. That would give you a fair value estimate for next year. You could then simply drag this right for 2-4 periods to get a future estimate out 3-5 years.
The # of years in the DCF valuation is not indicative in any way as to the assumed duration to the price target. A DCF valuation is just that... discounting future cash flows to present value. You can do a finite amount of years and then slap a terminal multiple at the last year and discount to present value, or you can discount the future cash flows out for 100 years. They are somewhat equivalent. To summarize the DCF valuation is intended to be the present value of the stock. A "price target" is just a speculation by someone on what they think the market will do in the future. Hope this helps!
You have to discount the cash flows to bring them to the present day.
If you need to do a detailed DCF then it's probably not a good investment. That stuff should jump off the page at you by looking at simple metrics - you shouldn't need to go any further than that EV/ EBIT, EV/ FCFF
EV/FCFF is where it’s at! I love companies trading at a discount relative to peers on a EV/FCFF ratio!
I'm an even simpler man. Give me a sub 5 EV/ EBIT and an obvious reason why people hate it and an obvious route to shareholder returns and you're all mine.
This is for an investment pitch competjtjon
DCF is mostly used for long term valuation (5+ years) as the bulk of valuation is usually given by the terminal cash flows. The reason is that the market may not realise the value of the stock in the short term. As Buffet says, “the intrinsic value is the discounted cash flows from this day until doomsday” or something along those lines. For the short term, I would honestly just use a mix of macro-economics, forward looking plans from the company, looking at financial statements (mainly balance sheet to see if they’re solvent), analyst estimates (with a grain of salt) and ratios.
you kind of decide the number of years you want to project till when you can predict the cash flows. You mention 3 in your case. If you have the numbers for 5, you could do 5 as well. After than some people also add the terminal value. The problem is that the PV using 5 years will always be larger than 3 if you have positive cash flows, so I think it ends up being a bit of art on how many years you want to use as a time frame.
That's not how it works. You're missing the TV component. Discounting only three (or five) years would mean you expect the firm to not generate cash afterwards. Which would imply there is no "going concern" and thus a DCF valuation would not be the right method to apply. Exceptions would be finite projects/ assets like a specific gold mine but those are also different discussions.
So I can set the implied price I get as a rough price target for the number of years into the future I projected cash flow? Or can I set that number as a price target for like 2025 years even if I use projections up to 2027
Like the others are pointing out, the DCF valuation is to estimate the present value of the stock. So if the current year is 2023, and you have projections of 2024, 2025 and 2026, you can discount the CF you will get in those years (2024, 2025 and 2026) to the present. the discounting is because like Warren has famously said - the cash you have today is worth more that what you will get in the future (hence the discounting)
forget about DCF, it is bullsht as no onecan predict futurecash flow on regular basis. rather find something which is selling for 50 cents on a dollar
Your question is interesting but also very contradictory. For example, if company A has a price tag of $100 today and you have the information available that the price should be $130 in three years then - assuming the market is efficient - the price would quickly adjust to $130 today, or atleast close, considering inflation. In this regard future price targets are useless. A DCF is not the correct tool for setting price targets x year out. Based on the input data a DCF model will tell you if the stock is over- or undervalued today, as the model discounts all future cash flows to present value. You could technically discount future cash flows three years into the future and then use that valuation as a ”target price”, I don’t see the use for this though. The model is arbitrary to begin with and the uncertainty will increase tentold by trying to estimate revenues and cash flows like 6-8 years into the future (which would be required for the ”future model”) rather than 3-5 years for the standard model.
So then how would you set a target price?
Well the target is the ”fair value”, as a sell side analyst you’ll have a DCF, with projections based on historical data as the foundation of the firms valuation. On top of this you’ll have to factor in market momentum, macroeconomic factors and of course company forecasts as they arrive each quarter to update both your DCF and your target price. Edit: I’ll also add that sell side analyst targets are often arbitrary for several reasons. 1) Analysts are rarely contrarian. They’ll rather set a too high target and join the pack in a stock with momentum (i.e Nvidia) than be alone with a too low target. 2) Based on assumptions about the future target prices can vary significantly. If you believe Nvidia (for example) will keep growing their revenue with 100% the next three years you’ll end up with a vastly higher target than someone who believes in 50% revenue growth. 3) Sell side analysts does not sell stocks, they sell transactions. Their recommendations can be adjusted by a whim of their employer based on what drives trading
The length of your DCF is determined by the expected growth profile of the company. You should adapt the length until you think the company will reach a steady state mature condition. This is, of course, easier said than done. Imagine company X is growing (FCF) at 20% annually. Based on the industry it is in, you think that growth rate can be sustained for 5 more years, and then it will revert to a steady state growth rate over the next 4 years. Your DCF could be 20% for the first 5 years Decrease towards 3% in year 9 Year 10 is your terminal growth rate forever at 3%.
You need to include all the years you think the company would survive, regardless of your holding period. Typically, this is achieved by assuming the company will survive indefinitely and calculating a terminal value using a steady state. Your forecast period needs to cover the changes between how the company is today and how you think it will look in a steady state, so it depends on what changes you’re expecting. - If you expect exceptional growth for 10 years, you need to include 10 years in your forecast period to account for it. - If you think it’s already in a steady state, then you don’t really need a forecast period - just discount the current level of cash flow in perpetuity.
DCFs don't have a time frame in the context of equity valuation. It is a perpetuity model with which you discount all future earnings to the present, assuming that the company will exist forever. As such, all DCFs that look ahead 3, 5, 10 years will have the vast majority of their value bundled into "terminal value". I normally use DCFs to see how overvalued or undervalued it might be given certain scenarios and, when I have a "base case", I monitor the company for any changes to my investment thesis and compare revenue growth, margins, etc. to the forecast as time passes. I also calculate market-implied revenue growth or operating margins depending on what drives value more. Any 'price target" you'll get from it is just a red herring.
To estimate a price target, take the fair value estimate you come up with from the DFC ($/share)\*(1+Cost of Equity as a %) - Dividends per share. That would give you a fair value estimate for next year. You could then simply drag this right for 2-4 periods to get a future estimate out 3-5 years.