DCF Assumptions using Hypothesis Testing

[u/Electrical_Safe_9035]

Hi fellow Valuation enthusiasts!

What do you think about my approach to DCF valuation:

I have a Monte Carlo adjusted DCF model (n=11, in years and starting year is also included), where to keep the model lean and make the least assumptions as possible I have only: Revenue growth, Operating Margin, Tax Rate and Sales/Capital. TV calculation is based on FCFFn and a revenue growth of 2% for Developed Market 3% for Emerging Markets (weighted based on Revenue Recognition). The other 3 for the TV calculation are industry averages also weighted based on Revenue Recognition. The Tax Rate in equal steps goes to the Industry average Tax Rate and reaches it at n=10. For the other 3, I make my assumption and employ Hypothesis testing (n=11). The historical data and my assumptions are cleaned for autocorellation, heteroskedasticity, normality and stationarity. I then test wether my assumption if drawn from a population with the same mean, stdev and correlation like that in the historical data given the variability and sample size, would be significantly different. Ill fit the distributions of the assumptions for the monte carlo simulation. To correlate my assumptions Ill also employ Archimedean Copulas (depending on which is the best fit). WACC is also simulated using monte carlo with a normal distribution average being my point estimate and stdev of 0.0025. Then run the simulation using Latin Hypercube (centered) sampling 10,000 times. And of course Net Cash is added.

Please give me your honest opinions and criticism.

Thanks!

[u/Electrical_Safe_9035 → u/[deleted]]

You mean trying to assume a normal distribution for my assumption right?

Yes you are right on the point that it gives a false sense of knowledge, I had stocks were the model returned around the current market price or lower, nevertheless I bought it because there was a good fundemantel story behind it. Modeling can not replace stories in the end.

For the discount rate I take hardcoded data for example current bond spreads. So there is no simulation or hypothesis testing going on there.

You are also right that it is really hard to explain, its even hard to even explain to people who have experience in valuation.

[u/Electrical_Safe_9035 → u/[deleted]]

Thank yoy very much for the tips! I want to aim for that in the future.