DCF or Discounted Cash Flow if you do your research, has been said to be one of the most preferred valuation model. It is preferred due to its assumed accuracy in terms of projecting what the valuation of a business based on what is projected down the road.
I like cashflow, it is one of the most important measurement on how well a company or business is doing. But DCF is all bullshit. Why?
I have done tonnes of them (DCF) and everytime I feel that I am bullshitting. Most of the time, the DCF that I do is for the company I work for or to make someone happy that the company is worth so much. From a DCF, one can just make a major change to a valuation based on a slight change in the assumption.
Before we go further, what is a DCF? DCF is a method of projecting a company's worth using mainly the future cashflow of a business and a discount value. Both are equally important. But both are equally difficult to project.
A future cashflow - imagine for a business, can some company project its cashflow say 5 years down the road? Or perhaps 10 years down the road? If that person being the CFO, CEO can project that close to accuracy, then he / she is almost superhuman. Future numbers are amazingly hard to predict. It is like someone (a super analyst) projecting what is the Bursa KL Composite say in 31 December 2018. People change, situation changes, management move around. And are you telling me management is not important in a business? Well DCF is saying that, isn't it. DCF can be assuming a scenario 20 years down the road and we are supposed to be taking the number say 2034 as correct for the valuation to be accurate.
In a DCF, the projection is not only for one year, but for a period. If it is for 10 years, then it is for 2014 to 2023 or even in perpetuity. And it has to be almost accurately provided. Can a business be consistent? Some yes, mostly no. In fact, very few yes. Then how are we to provide a DCF accurately?
Then comes the discount value! A 1% difference, in a lot of times cause significant changes to the valuation. So which number to use 10%? 11%? 12%?
Why the hell then someone still wants to use DCF. Most probably, the current valuation is not good enough. And most of the time that current value is not good enough, some guy has the indigenious thought of why don't they come out with a projection over a long stretch of years and project the value backward, considering time value of money.
Well, if someone wants to bullshit another, you can contact me to do the future cashflow for you and discount them to today's value, cause I am pretty good at that!
For investment though, go for the tried and tested, based on historical track record and what you feel the business is heading in the future.
There are only some businesses which a DCF can probably be used - mostly concessions. Even then other factors are so important.