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.