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Michael Mauboussin: Everything is a DCF Model

In this article, Michael Mauboussin argues that whenever investors value a stake in a cash-generating asset, they are essentially using a discounted cash flow (DCF) model, whether explicitly or implicitly. This concept applies broadly across various asset classes and investment strategies. Although few investors explicitly use DCF models all the time, keeping the drivers of the model in mind is essential for understanding and evaluating investments across various asset classes.

Based on this conclusion, Michael introduces the mantra “everything is a DCF model”.  He explains that the intrinsic value of an asset is determined by the present value of its future cash flows. This principle applies to a wide range of investments, including stocks, bonds, real estate, and private equity. Even when investors use shortcuts or heuristics for valuation.

Here are the Key takeaways:

  • Michael addresses several reasons why DCF models are not more widely used, including: The general efficiency of public markets in valuation, the sensitivity of DCF models to small changes in assumptions and the prevalence of comparative valuation methods.
  • Despite its limitations, the value of any cash-generating asset is fundamentally based on the present value of its future cash flows, making DCF models universally applicable.
  • Understanding DCF principles is crucial for effective valuation and investment decision-making, even when using other valuation methods or heuristics.
  • Investors should focus on assessing the expectations embedded in current market prices rather than trying to determine exact values using DCF models.

The value of an asset that produces cash is the present value of the cash flows it generates over its life. Few investors explicitly use a DCF model all the time, but it is useful to keep the drivers of the model in mind constantly.

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The above has been prepared by Børsgade ApS for information purposes and cannot be regarded as a solicitation or recommendation to buy or sell any security. Nor can the information etc. be regarded as recommendations or advice of a legal, accounting or tax nature. Børsgade cannot be held liable for losses caused by customers’/users’ actions – or lack thereof – based on the information in the above. We have made every effort to ensure that the information in the above is complete and accurate, but cannot guarantee this and accept no liability for errors or omissions.

Readers are advised that investing may involve a risk of loss that cannot be determined in advance, and that past performance and price development cannot be used as a reliable indicator of future performance and price development. For further information please contact info@borsgade.dk

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