Discounted Cash Flow Analysis

[allan_nalla]

Hi guys, could someone versed in DCF Analysis help identify the flaw in my theory below?

So in DCF Analysis, most of the time we're supposed to project the Unlevered Free Cash Flow. After viewing many sites and tutorials, all are saying that we should take the NOPAT (instead of Net Income) figure and make the necessary cash adjustments.

If that's the case, why can't I just use the OCF Figure reported in Annual Reports and add back the interest expense deducted in the income statement?
This should essentially reconcile with the prior figure.

i.e.
Usual Way
EBIT - Taxes = NOPAT

Therefore,
NOPAT
+- Necessary Changes
- CapEX
=Unlevered Free Cash Flow

My Theory
OCF as reported + Interest Expense - CapEX = Unlevered Free Cash Flow


What's wrong with this theory?
Because obviously there is, otherwise, I don't see why it's not taught this way.

 

[wahkao3]

so mani theories

school assignment ah?

 

[allan_nalla]

so mani theories

school assignment ah?

I wished. If this was school, at least I would have a teacher to ask.
I'm self-teaching.

 

[Perisher]

so mani theories

school assignment ah?

Can you help him out?

 

[SpeedingBullet]

Hi guys, could someone versed in DCF Analysis help identify the flaw in my theory below?

So in DCF Analysis, most of the time we're supposed to project the Unlevered Free Cash Flow. After viewing many sites and tutorials, all are saying that we should take the NOPAT (instead of Net Income) figure and make the necessary cash adjustments.

If that's the case, why can't I just use the OCF Figure reported in Annual Reports and add back the interest expense deducted in the income statement?
This should essentially reconcile with the prior figure.

i.e.
Usual Way
EBIT - Taxes = NOPAT

Therefore,
NOPAT
+- Necessary Changes
- CapEX
=Unlevered Free Cash Flow

My Theory
OCF as reported + Interest Expense - CapEX = Unlevered Free Cash Flow


What's wrong with this theory?
Because obviously there is, otherwise, I don't see why it's not taught this way.

Hmmm, I do see certain people using EBIT, FCF, EBITDA, NOPAT for their DCF models, it all depends on what you wish to project in the future. There's no right or wrong way but yes, Unlevered FCF is the standard usually used.

I think it really depends on your personal preference really. Like for example, if a company has very volatile FCF, and many do, one would have to normalize it, then give a projection (year one FCF +1bn, year two -2bn, year three +100m). Many people view using NOPAT would be better as it's less deviant than FCF before all cash adjustments.

 

[allan_nalla]

Hmmm, I do see certain people using EBIT, FCF, EBITDA, NOPAT for their DCF models, it all depends on what you wish to project in the future. There's no right or wrong way but yes, Unlevered FCF is the standard usually used.

I think it really depends on your personal preference really. Like for example, if a company has very volatile FCF, and many do, one would have to normalize it, then give a projection (year one FCF +1bn, year two -2bn, year three +100m). Many people view using NOPAT would be better as it's less deviant than FCF before all cash adjustments.

Ohhh. I see! I was reading so many different versions until I'm so confused. Thanks so much for your input.

But is my calculation for NOPAT, by taking (OCF + Interest Expense) similar to (EBIT - Taxes - WC Changes - Other Changes)?

 

[wahkao3]

so many versions. pattern like badminton
If u ask me which to take, I simply take the very bottom line, net profit.

i believe all the other versions are used by investment bankers to make things look hellishly complex to their clients, and also to massage the ratios.
eg. Price/EBITA maybe only 5, but Price/net profit is at 10. Price/EBITA makes the company looks really cheap by stripping away some costs. This cheap optical illusion makes the deal more attractive to the client eh?

otherwise, how to justify paying them millions?

 

[GiraffeValue]

Hi guys, could someone versed in DCF Analysis help identify the flaw in my theory below?

So in DCF Analysis, most of the time we're supposed to project the Unlevered Free Cash Flow. After viewing many sites and tutorials, all are saying that we should take the NOPAT (instead of Net Income) figure and make the necessary cash adjustments.

If that's the case, why can't I just use the OCF Figure reported in Annual Reports and add back the interest expense deducted in the income statement?
This should essentially reconcile with the prior figure.

i.e.
Usual Way
EBIT - Taxes = NOPAT

Therefore,
NOPAT
+- Necessary Changes
- CapEX
=Unlevered Free Cash Flow

My Theory
OCF as reported + Interest Expense - CapEX = Unlevered Free Cash Flow


What's wrong with this theory?
Because obviously there is, otherwise, I don't see why it's not taught this way.

Sorry to burst your bubble. All those are considered speculation in Ben Graham definition.

Projecting earning is big no no. That is against the true teaching of value investing.

 

[SpeedingBullet]

Ohhh. I see! I was reading so many different versions until I'm so confused. Thanks so much for your input.

But is my calculation for NOPAT, by taking (OCF + Interest Expense) similar to (EBIT - Taxes - WC Changes - Other Changes)?

Yes that should be fine. NOPAT is way more complicated than FCF, why not just use FCF?

so many versions. pattern like badminton
If u ask me which to take, I simply take the very bottom line, net profit.

i believe all the other versions are used by investment bankers to make things look hellishly complex to their clients, and also to massage the ratios.
eg. Price/EBITA maybe only 5, but Price/net profit is at 10. Price/EBITA makes the company looks really cheap by stripping away some costs. This cheap optical illusion makes the deal more attractive to the client eh?

otherwise, how to justify paying them millions?

U take the bottom line of just net profit and for many cases, you'll miss out on one-time gains/losses that will severely distort your valuations.

You accuse bankers of massaging numbers to create illusions, did you know net profit can easily be massaged as well?

Sorry to burst your bubble. All those are considered speculation in Ben Graham definition.

Projecting earning is big no no. That is against the true teaching of value investing.

Disagree.

Graham's methods are more or less extinct in today's markets. You don't see Buffett and other value investors going around buying net-nets nowadays.

DCF is a highly criticized method but it's the very foundation of corporate finance since all companies' stock prices are determined by the present value of future cash flows. Sure, market irrationality might cause a deviation from the mean once in a while to create opportunities, but it's in no way considered a speculative activity.

Graham's method is simply looking in the past, not the future, which is already dated.

You said "true teaching of value investing" - that's highly debatable as many ppl define it differently. It can mean buying a company selling at a discount to intrinsic value (after being projected out by DCF model), or other things. What do you mean by that anyway?

There are many great companies that deviate from Graham's idea of a value stock, and if you follow his methods to the tee, you'll miss out on many opportunities. Apple is one.

I think what you mean is confirmation bias - ppl inflating variables in DCF to arrive at unrealistic IVs. Yeah that happens alot, im guilty of it in the past.

To properly use DCF or any of its variants (DDM, ERM, etc.), one has to be prudent in his calculations. Perpetual Growth and Terminal Value are prolly the things that the crazies love to distort. Hey this company can grow at 5% forever, after 50 years, its EBIT will be equal to Singapore's GDP

 

[allan_nalla]

Yes that should be fine. NOPAT is way more complicated than FCF, why not just use FCF?

Thanks a lot! That clears my self-doubt.

Well, it's actually because I am still on my learning track. I used to use FCF, but like you said, when the company is generating inconsistent FCF, it is very hard to projections, until I came across online articles suggesting they use NOPAT. Then I thought, "Alright, this seems more plausible." :/

Thanks for your help once again!

U take the bottom line of just net profit and for many cases, you'll miss out on one-time gains/losses that will severely distort your valuations.

You accuse bankers of massaging numbers to create illusions, did you know net profit can easily be massaged as well?

Exactly.


P.S: @Perisher, I don't know if you guys are supposed to close threads when the thread starter's questions have been answered. If so, you can proceed. Unless this can be used for DCF discussions.

Thank you.

 

[Perisher]

P.S: @Perisher, I don't know if you guys are supposed to close threads when the thread starter's questions have been answered. If so, you can proceed. Unless this can be used for DCF discussions.

Thank you.

I don't close thread much, haha. Lazy mod. Feel free to discuss how you use it to assess which stocks got good potential. I will just leech it off the pros here.

 

[SpeedingBullet]

Keep it open lol, dcf is highly controversial, im sure there're many that will disagree w my views, wld like to read from them

 

[wahkao3]

U take the bottom line of just net profit and for many cases, you'll miss out on one-time gains/losses that will severely distort your valuations.

yes agreed

You accuse bankers of massaging numbers to create illusions, did you know net profit can easily be massaged as well?

yes agreed. net profit is already distorted as it is, we no need more bankers to add onto the distortion

 

[wahkao3]

I don't close thread much, haha. Lazy mod. Feel free to discuss how you use it to assess which stocks got good potential. I will just leech it off the pros here.

dont close dont close! keep it open. THis is a good thread

 

[Perisher]

Won't close this thread. No worries.

 

[allan_nalla]

Since this thread won't be closed. I shall try something fun. :/

I'm posting my projections that I made when analyzing Whole Foods Market ('WFM'). I just thought it might be interesting if someone could offer some constructive criticisms.

In my opinion, I have been very prudent and conservative when making these projections after reading their past 3 annual reports and current outlook for them from news reports.

 

[Perisher]

Since this thread won't be closed. I shall try something fun. :/

I'm posting my projections that I made when analyzing Whole Foods Market ('WFM'). I just thought it might be interesting if someone could offer some constructive criticisms.

In my opinion, I have been very prudent and conservative when making these projections after reading their past 3 annual reports and current outlook for them from news reports.

If you don't wish to post the image, let me know. Will take it down.

 

[wahkao3]

Since this thread won't be closed. I shall try something fun. :/

I'm posting my projections that I made when analyzing Whole Foods Market ('WFM'). I just thought it might be interesting if someone could offer some constructive criticisms.

In my opinion, I have been very prudent and conservative when making these projections after reading their past 3 annual reports and current outlook for them from news reports.

Whole Foods Market Inc was incorporated in Texas in 1978. It completed its initial public offering in January 1992. The Company is a retailer of natural and organic foods and a Certified Organic grocer. It has one operating segment, natural and organic foods supermarkets. The Company offers natural and organic products with a strong emphasis on perishable foods. Its product selection includes, but is not limited to: produce and floral, grocery, meat, seafood, bakery, prepared foods and catering, coffee, tea, beer, wine, cheese, nutritional supplements, vitamins, body care, and lifestyle products including books, pet products, and household products. Its main competitors include local, regional, national and international conventional and specialty supermarkets, natural foods stores, warehouse membership clubs, online retailers, smaller specialty stores, farmers markets and restaurants. Its main trademarks include: Whole Foods Market, the Whole Foods Market logo, 365 Everyday Value, the 365 Everyday Value logo, AFA, Allegro Coffee Company, Americas Healthiest Grocery Store, ANDI, Awesome Eats, Bread & Circus, Capers Community Market, Dark Rye, Eco-Scale, Fresh & Wild, Fresh Fields, Grab & Give, Greenlife Grocery, Green Mission, Harrys Farmers Market,. The Company is subject to various local, state, federal and international laws, regulations and administrative practices affecting its business.




my opinion:
TA bad
FA good, but priced in liao. not much meat left

TA and FA both nv say buy. dont buy

Sorry I am not a DCF guy. I feel that DCF ish rubbish in, rubbish out

this was a great growth company 2 years back but I think it has saturated its market and the growth is tapering off liao

 

[wahkao3]

If you don't wish to post the image, let me know. Will take it down.

so whats the fair value according to your DCF ah??? why no fair value??

 

[wahkao3]

a funny thing i noticed about WFM

Even though the growth is there, but its share price is in down trend

Morale of the story, dont be hard up over growth!