Estimating a growth rate for Discounted Cash Flow?

Question

I understand a lot of the worlds best investors calculate a company's intrinsic value by doing a Discounted Cash Flow analysis. However, how do investors comfortably determine a growth rate of owner earnings when it is not linearly increasing? Do they still just take an average over past years?

Answer 1

Since they (generally speaking) aren't talking all we can do is hypothesize.  My hypothesis is that they do a best case, worst case, expected case analysis.

Just project the first two and then (depending on if you are an optimist or a pessimist) do something like a 1/3  2/3 weight to arrive at an expected case.

Hope this helps

Jerry-the-bookkeeper

Answer 2

Past trends are always a good starting point, but the more important piece is the projection of a company's future earnings.

It's always a subjective estimate because you're trying to quantify things that are hard to quantify like for example:  changing market and/or economic conditions, competitive forces in the marketplace, obsolescence factors that might develop, changes in consumer habits/preferences, just plain old supply and demand factors, etc

Base your projection on as much hard data as you can to start with.  Then, as for the soft (subjective) issues, you gain credability by listing (in writing) your assumptions that drive the issues and take your best shot at it. That way, the bosses can "chew on" and agree or disagree with your assumptions, make changes if need be, etc.

Hope this helps, mule