James Montier: On The Dangers Of Discounted Cash Flow
I read one of Jim Montier’s books two years ago and completely forgot to follow up on his writings. Jim Montier is an economist and global equity strategist at Dresdner Kleinwort Wasserstein and also writes a column titled Mind Matters for Societe Generale. Yesterday I came across two of his recent articles, here is the first one on the dangers of the discounted cash flow model. Click here to read about the dangers of discounted cash flow
Article Introduction (Via Societe Generale: Mind Matters)
Theoretically, discounted cash flow (DCF) is the correct way of valuing an asset. However, as Yogi Berra noted, “In theory there is no difference between theory and practice. In practice there is.” The implementation of a DCF is riddled with problems. First off, we can’t forecast, which kind of puts the kibosh on the whole exercise. Even if we choose to ignore this inconvenient truth, problems with the discount rate still make a mockery of the whole idea of DCF. No wonder DCF has such a poor reputation. The good news is that several alternatives exist. We explore three that avoid forecasting altogether!
Article Excerpts (Via Societe Generale: Mind Matters)
“Whilst the algebra of DCF is simple, neat and compelling, the implementation becomes a minefield of problems. The problems can be grouped into two categories: problems with estimating cash flows and problems with estimating discount rates.”
“One of the recurring themes of my research is that we just cant forecast. There isnt a
shred of evidence to suggest that we can. This, of course, doesnt stop everyone from
trying.”
Alternatives to Traditional DCF models include:Reverse Engineered DCFs, Asset Values, & Earnings Power
Click here to read about the dangers of discounted cash flow
