What Is the Connection Between Discounted Cash Flow and Net Present Value?

The discounted cash flow method is to determine the pricing method of the stock issue price by predicting the company's future cash flow and calculating the company's present value at a certain discount rate. The investment stocks bring to investors mainly include dividend income and the difference in income from the last sale of stocks. The key determination using this method is: first, the expected cash flow of each year of the company's future duration; second, to find a reasonable and fair discount rate, the size of the discount rate depends on the risk of future cash flows obtained, The greater the risk, the higher the required discount rate; vice versa. ^[1]

Discounted cash flow method

The discounted cash flow method is to determine the pricing method of the stock issue price by predicting the company's future cash flow and calculating the company's present value at a certain discount rate. The investment stocks bring to investors mainly include dividend income and the difference in income from the last sale of stocks. Key determinations using this method: First, anticipate the future of the business

Any fund has a cost, that is, time value. As far as the essence of business operation is concerned, it is actually a cash expenditure behavior aimed at increasing wealth. in

The so-called value evaluation refers to the value judgment made by the buyer and the seller on the subject. in

The discounted cash flow method is capital investment and

Take an extreme example to illustrate the method of gross valuation of the company's intrinsic value using the "thinking of future cash flow discounting" method.

Suppose there is a company, such as "American Tiger Tooth". Here are all the assumptions:

1. No debt, no more. (With net cash)

2. The stock issuance is permanent. (Actually it has been changing due to option and repo reasons)

3. Every year, 1 billion US dollars of cash flow (exactly = net profit) is recorded, and the recorded cash flow is distributed to shareholders every year. (Cash flow is more than 1 billion but profit does not arrive, no dividends are paid)

4. Owns 30% of the shares of Japan Tiger Ya. After 2020, the market value will be 50 billion US dollars. (Maybe higher, who knows? Tiger teeth are more popular than dog teeth in Japan)

5. Owns 30% of the shares of Hong Kong's "All the Way" company. After 2020, the market value will be 100 billion US dollars. (Oh, the CEO has this confidence, I also think it is possible, but not sure)

6. Owns 40% shares of Granny Allah, an unlisted company in mainland China. The company went public in 2015, with an ipo price of $ 50 billion and a market value of $ 150 billion by 2020. (Very likely)

7. In 2020, a company in the United States called "quite hard" bought the US part of "American Tiger" for US $ 20 billion, and at the same time, stocks of other assets (3 listed companies)

Directly distributed to all "American Tiger" shareholders. (It doesn't matter if nobody buys it, just for the convenience of calculation.)

8. Do not consider the taxation of dividends and stocks received by shareholders. (How could there be no tax?)

9. Assume a discount rate of 6%. (If it is 4% or 5%, the difference is quite big, who is fine?)

Calculate how much this "tiger tooth" can be worth:

a. Annual income of 1 billion yuan for a total of 10 years: 10 + 10 / 1.06 + 10 / (1.06 square) +. . . + 10 / (1.06 to the power of 9) = 10 + 9.43 + 8.90 + 8.40 + 7.92 + 7.47 + 7.05 + 6.65 + 6.27 + 5.91 = $ 7.802 billion.

b. The discount of "Japanese tiger teeth": 500 / (10th power of 1.06) * 30% = $ 8.376 billion.

c. The discount of all the way: 1000 / (10th power of 1.06) * 30% = US $ 16.752 billion.

d. The discount of "Grandma Allah": 1500 / (10th power of 1.06) * 40% = 33.504 billion USD.

e. The "pretty hard" discount: 200 / (10th power of 1.06) = $ 11,168 million.

a + b + c + d + e = US $ 77.602 billion. If all of the above assumptions are true, this should be the "intrinsic value" of the company. The problem is that in fact all the above conditions are hypothetical, and changes in any one condition will change the intrinsic value of this company. This is just 10 years. In fact, it may be clearer (but more difficult) if a company can be evaluated for a longer period of time. It is difficult to understand or judge whether all the conditions are true. According to Munger, it is not easier than being an "ornithologist" (or "economist").

A special note: If a company has a lot of cash in hand but has not been able to add value, this cash will depreciate in the long run. The problem is that if this cash is not used well, the depreciation will be faster.

The disadvantage of this example is that b, c, and d all use market value, which will deviate from the intrinsic value.

All the above data is assumed for the convenience of calculation and has nothing to do with any real company.

Extended conclusion: Cigarette-type investments may have lower returns than good growth companies. This is known as Munger's contribution to Buffett.

In addition: the best example of this approach may be real estate. Discounting future cash flows to calculate today's price is not expensive. Here the future cash flow is referred to as (rent-expense). Don't understand think about the house. If you don't understand it, go back and watch "Poor Dad". If you understand, you can have a chance to become "Father Dad". ^[3]