I 100% agree with you. DCF has so many flaws and is in many ways a guessing game. Why should your projections be the ones that are right, and not those of the guy selling to you? It also has the tendency to compound errors as you go further into the future.
What’s more, a 1% difference in the discount and growth rate can lead to values that differ by as much as 100%!!! (search up Greenwald’s example).
I think that’s what makes investing beautiful — the idea that there is no perfect formula or math equation that you can use to get your answer. The future is, by definition, uncertain so trying to project cash flows 10 or even just 5 years out is a highly speculative process. Thanks for the piece!
My solution: Use a fixed 10% discount rate for all investments regardless of size or risk.
Your discount rate should equal your minimum hurdle rate for what you want to earn as an investor.
The only form of DCF I'd use is the simple Gordon Growth Model: Price = Dividend Yield / (Discount Rate % - Growth Rate %)
Or you can swap out Dividend Yield for Earnings Yield.
The fewer the assumptions the better.
I 100% agree with you. DCF has so many flaws and is in many ways a guessing game. Why should your projections be the ones that are right, and not those of the guy selling to you? It also has the tendency to compound errors as you go further into the future.
What’s more, a 1% difference in the discount and growth rate can lead to values that differ by as much as 100%!!! (search up Greenwald’s example).
I think that’s what makes investing beautiful — the idea that there is no perfect formula or math equation that you can use to get your answer. The future is, by definition, uncertain so trying to project cash flows 10 or even just 5 years out is a highly speculative process. Thanks for the piece!