Discount Cash Flow Models Explained!!!

September 11, 2014 by 2 Comments

Before I get into the first evaluations of stocks, I want to first explain what exactly I will be doing over the upcoming weeks, and how I will reach a conclusion. As we all know, a stock represents a portion of a company that one owns. However, for the purposes of my models, we will be defining the price of the stock as the sum of a company’s current and future cash flows. This represents all the cash that would be available to investors after expenses.

This seems very ambiguous at first, but it is through this idea that the following equation has been derived. This is known as a Discounted Cash Flow (DCF) model. The equation is as follows:

DCF= Cf1/(1+Wacc)^1+Cf2/(1+Wacc)^2….+Cfn/(1+Wacc)^n+(Fct*(1-g))/(Wacc-g)

This equation basically is a summation of the total cash flows per year (Cf) as it approaches the terminal value n+1 (This exact part of the equation I will discuss later in the article), and then each year the money is discounted to take into account inflation, depreciation, and other various costs through the weighted average cost of capital (WACC). Basically this equation calculates the total amount of money made over n+1 years, and then calculates it in terms of today’s values utilizing the WACC. To calculate WACCC we must utilize the following equation:

WACC=(E/V)*Re+(D/V)*Rd*(1-Tc)

This equation basically weighs the average of a company’s total capital in terms of both the market value of the company’s equity (E) and the market value of the company’s debt (D) and then dividing it by the sum of E+D, which is represented through the term V. We then must ask ourselves, what are we weighing? The two costs we are weighing are the cost of equity (Re) and the cost of debt (Rd) after taking out the corporate tax rate (1-Tc). WACC basically represents the amount of debt that must be paid to keep the company afloat, aka Rd, and the amount the company must do in order to appease share-holders (Re).

But then, you are now asking what Re and Rd represent. Rd is simply the rate the company is currently paying on its debt. Easy enough right? Re is then basically the percentage return required on an investor’s investment into the company to justify their investment based on the risk involved. It is calculated through the following equation.

Re=Rf+Ba(Rm-Rf)

In this equation, Rf represents the risk free rate, or the percent interest, on a 90 day US treasury bill (at least for the work I will be doing over the following weeks). Ba represents a company’s volatility within the market. It means for every point the market rises or falls, the company’s stock goes Ba in that direction. Finally Rm is the projected growth rate of the entire market for the year.

Hopefully that wasn’t too confusing, but that is the basis for the model, so let us move back to the original DCF equation. In order for me to project the free cash flow of the company, I will go back through the financial statements of prior years and determine the percentage of the company’s revenue that is spent in operating costs, taxes, net investment, and the change in working capital from one year to the next. I will then forecast a growth rate for a period of 5 to 10 years in the future, saying each year that these percentages will continue (potentially small changes on my part, if I notice one of the costs decreases as a percentage as revenue increases), and then I will guess that the company will grow x% each year, this percentage slowly tapering off as a company’s market presence and competitive advantages dwindle till it reaches a terminal value. The terminal value is the final part of the DCF equation, which I told you earlier I would discuss now. Basically, this is the free cash total for every year after the final year n I forecast. A company eventually will hit a point where it will grow with the economy; this is known as the perpetuity rate (g). It is the rate we will assume the company will grow forever after n years. This terminal value allows us to account for cash flows that are too far in the future to project.

So now that you, hopefully, understand how this model works, I can begin to utilize it in the future with your understanding of what I am doing. The final number offered through this long calculation is the total market capitalization of the company. We can then divide this number by shares outstanding and a get a stock price per share. As you can tell however, due to the guess work involved, this is in the end more of an art than a precise science, so a margin of error must be assumed and taken account for before investing. Basically if the value I get is much higher than the current value, one should be bullish on the stock, but if the value I get is much lower than the current value, one should be bearish on the stock.

 

Filed Under: PASSION

RCL 9/4

September 4, 2014 by 4 Comments

One area presented by Adiche in the novel that I feel is the perfect example of a civic space is the hair dresser where Ifemelu goes during part one to get her hair braided. This entire place is a perfect example of a civic community within the larger community of America. It is here that many Africans congregate and celebrate their heritage; they can be around others of similar descent, ideas, and appearance. One has to go only as far as to looking at the exchange between Ifemelu and Mariama. They both discuss various topics regarding their homeland, and they understand the cultural references to the Igbo and have debates. The shop if almost like a public forum of those culturally connected to Africa, where those who feel a civic connection to the country can congregate and celebrate their heritage. However, what Adiche’s main role of the inclusion of this particular part in the novel is, is to illustrate how one’s civic identity can change. Upon coming to America, Ifemelu constantly discusses how the American’s are ignorant of the African ways and even the geography of the region, as shown through her various criticizing, critical blog post about the people that anger her, yet, here is Ifemelu now being faced with an African who is ignorant of the American culture and even somewhat of her own heritage back home, as demonstrated through her belief that “Igbo marry Igbo”. That Ifemelu is even critical of those that she is trying to celebrate demonstrates how much she has changed since her transition to America. This sends a strong message to the reader that civic life is a fluid, constantly changing part of one’s personality, and that it is not simply something that is ingrained and stagnant throughout one’s life. It responds to trials, tribulations, and experience just as one’s personality evolves in the face of these challenges.

Filed Under: RCL

Stocks or Fantasy Football?

September 3, 2014 by 2 Comments

The first topic I would enjoy using for my passion blog would be doing a ‘Mad Money’ esque type blog, where every week I pick a different stock and utilize various valuations methods, both quantitative and qualitative, to determine the intrinsic value of the stock and give my opinion on whether one should be bullish or bearish on it.  I would basically go through my thought process on each stock, along with a brief description of the company and where they say they are heading.  Basically each stock would be examined through a discount cash flow model I create, the grade I give to the company’s upper management and their plans for the future, and various performance ratios examined in relationship to other companies in the same market.  I would then state any popular rumors about the future announcements of the company.

The second topic that I would consider doing, but is a bit more out of my comfort zone, would be a fantasy football blog where I choose a breakout and dud player for each position every week.  I would do this by looking at things like opponent, vegas betting lines, and past statistics about player performance in similar situations.  i would then end the prediction with an exact statline for each player that I expect.

Filed Under: PASSION

RCL 9/2

September 1, 2014 by Leave a Comment

For this first assignment based on the chapter of our reading on rhetoric, I decided to answer the first question, which first asked me to look around and observe the rhetoric in the community around me. In order to do this, I took a walk down College Avenue and decided to just look at the stores and see the types of marketing they were doing. I passed subway, their multitude of “five-dollar foot long” posters cluttering the windows. I continued past the various restaurants lining the streets, the doors open, seducing nearby pedestrians to stop by as the smells of freshly made foods flood nearby noses. Yet, it was in my spur of the moment decision to stop at Harper’s that I realized how much rhetorical reasoning was put into both the layout of their store and display. As I walk towards the store, I immediately notice the “sale” sign they have on the window. This prompts me to decide to enter the store, and as I look around the front of the building, I immediately notice that they have placed the typical college clothing that is on sale at the very front of the store. Button down shirts and hats are marked at 50% off, and I immediately decide to buy a hat. Upon leaving the store I realized that I was just subconsciously persuaded by the rhetoric of the store to buy the hat. The store acted as the rhetor and put forth the proposition that I should purchase their on-sale items. Enticed by the argument and partially persuaded by the logos put forth in the fact that the items were selling at a mere half the price, I enter the store. Upon entering the store, I am then hit by the ethos of the ornately decorated store. The workers in suits, various ties and formal attire laid out on racks, planting the idea that this store can be trusted and has top tier items. Then, by seeing the clothing that I wanted at the very front, the layout of the store established pathos by forcing me to see the discounted goods and instilling a desire to purchase that would not have been there had these items been in the back, out of sight and out of mind. The store easily persuaded me, and I was down twenty dollars for a hat.

To address the second part of the question prompt regarding whether authority figures utilize fact or other means to convince people to accept their side, I would argue that it is a combination of both facts and other means. Facts from a rhetorical standpoint in today’s world are flung around so haphazardly that they have lost their value. Very few people can actually invent arguments that can persuade those around them. I believe that in most situations, one must be persuaded by an invention, and THEN have their belief strengthened by facts only after accepting the opponent’s opinion. Throwing facts around does not foster a conversational, discussion based environment where people can freely change opinions and throw around ideas. The moment people start to hear facts, an almost mental barrier is thrown up, and the opposition begins to stubbornly throw their own facts at the opposition, resulting in what is ultimately a catch 22 where neither side moves closer to persuading the other.

Filed Under: RCL
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