Take a company like Ford , if you would go 10 years back and create a DCF with the earnings that ford has IN FACT made over the last 10 years your numbers would be quite over its current share price! How can you ever rely on a DCF when it’s numbers are correct , the market does not follow it ! All the market cares about if the earnings are growing, it doesn’t matter if in past the company has made great a earnings, “so how is a DCF true”?
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2Apart from my answers to your 2 questions, I think it is worth pointing out that you are coming at this with a pretty 'assertive' suggestion that you disagree with these practices. Respectfully, it seems this is a new topic for you, and while you may not understand the concepts yet, and might disagree with common practice, you will likely get more out of the learning by having an open mind. That doesn't mean that current practice is always correct, and it definitely doesn't mean that my understanding / explanation is always correct. I just think you may be overly confident in how you disagree.– Grade 'Eh' BaconOct 19, 2022 at 14:08
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As an example of how I think you are being over-confident: You say that Ford's earnings over the past 10 years would be "well over its current share price". Well actually, I quickly ran the numbers here: ycharts.com/companies/F/net_income and it looks like Ford's earnings over 10 years are about $50B, and its current market cap is about $48B. But more importantly, I don't know why you think that 'earnings over the past 10 years' should = 'value today'. Those past earnings have either been reinvested or paid out as dividends already.– Grade 'Eh' BaconOct 19, 2022 at 14:12
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1I mean this very kindly - please reconsider attempting to value companies for individual stock picking. For nearly everyone, that level of risk isn't necessary and isn't worthwhile. At bare minimum, I highly recommend you spend a long time (years+) learning before you attempt to make stock purchases based on your analysis.– Grade 'Eh' BaconOct 19, 2022 at 18:54
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1the reason your analysis is incorrect, is that if I expect Ford to earn $10B next year, I will be willing to pay a price for its stock, on the expectations that it will earn $10B. If it then earns $10B as I expected... well great, that's why I bought it, and the price should more or less remain the same, barring other factors, because I already 'priced-in' that $10B of earnings.– Grade 'Eh' BaconOct 19, 2022 at 18:56
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1I don't think your questions are going to get you a better answer than the ones you have been given and apparently dislike. I'm on the edge of voting to close this as duplicate.– keshlamNov 18, 2022 at 16:36
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2 Answers
When you buy a company (or, a tiny % of a company, through a share purchase), you are buying two things:
(1) the net assets of the company today (assets less debts); and
(2) the future revenue that will become net cash in the future.
Figuring out #1 is somewhat straightforward. Figuring out #2 is difficult. There is some risk that earnings will be lower (or higher) than expectations, and you also need to consider the 'cost of money' over that time period. Because money earned over 10 years is worth less than money given to you today.
Looking at the past 10 years doesn't tell you what the next 10 years will look like, although it may be a starting point to begin to set expectations.
answered Oct 19, 2022 at 14:02
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Note that past earnings are already factored into the company's net assets Adding the income history to net worth would be double counting.– keshlamNov 18, 2022 at 23:17
Note first that "earnings" is not necessarily "cash flow". DCF uses cash flows to value an investment, which can differ from earnings.
Secondly, DCF must incorporate some measure of risk or uncertainty, which is expressed in the discount factor used. You took known earnings for the past 10 years, which, since they already happened, have no risk. In DCF, you must discount expected earnings in the future by some factor to account for the fact that the expectation may be wrong. If you took the actual earnings for the past 10 years and discounted them back to 10 years, ago, you'd get a much smaller number. The higher the discount rate, the lower the present value.
answered Nov 18, 2022 at 16:48
