I’ve been digging around, trying to find a way to really estimate the intrinsic value of companies and their shares. All I found is that intrinsic evaluation is an extremely flawed process.
I believe that any company has valuation that’s made up of the present value of future cash flows. However, largely discounted cash flow models are extremely poor ways of estimating the valuation of companies. They are far too sensitive to assumptions. And really, who knows what a company‘s future cash flows will actually be. Even Munger joked that many analysts build their DCF models with assumptions baked in that essentially just confirm their thesis.
The reverse DCF struggles from the same issues. You’re trying to solve for the assumptions at the market as making. But reverse DCF still requires you to make many of the assumptions yourself. A reverse DCF doesn’t measure the expectations of the market, a reverse DCF is just a hybrid of your assumptions and whatever the price is at that moment. What happens next? Most analysts will either say expectations are too high or too low based on what their thesis is. You’re again extremely reliant on your assumptions and the limited information you have available to then argue for an increase or decrease in upcoming share price.
Real options valuation can effectively be done in almost any company that has optionality that makes up a significant portion of its value. However, determining the components of those real options is in itself a pretty speculative process.
Asset based valuation in most cases is in particularly useful. Valuations today generally are quite inflated. If you ever end up with a company truly below it’s net current asset value, you often have a broken or a fraudulent company. Many companies trading at less than asset value are illiquid making them difficult and highly expensive to trade. Similar problems exist for companies trading below liquidation value. Many of these companies have heavy cash burn and will lose those assets before stockholders ever get a taste. Many of these companies trade above liquidation value because their management doesn’t intend to return value to stockholders. Many of these are also smaller companies or relatively illiquid.
There’s many more ways of valuing the intrinsic value of companies and I won’t go into all of them here. I’ve talked about some of the more common ones above. I just find the most methodologies of value companies are not terribly useful. I can’t really feel confident that I can create an intrinsic valuation that is reliable enough for me to feel that I have any margin of safety. Much less, be able to use intrinsic valuation strategies to create a portfolio that will match the returns of the S&P 500.
I’m curious. What do people hear think? What strategies do you use for valuation? How do you generate a margin of safety? What are your returns?