DCF Valuation Stages

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Posted by Bob on April 09, 19101 at 13:34:25:

The suite of investment models can handle most of the equity valuation situations encountered by individual investors in common stocks. Also, the Model Chooser assists in identifying the most appropriate model to use in any particular situation.

For example, the two-stage models are designed to handle a situation where one growth rate is expected initially, say during the first 3 to 5 years in Stage One, but a different growth rate is expected thereafter, say during the subsequent 17 to 15 years in Stage Two if the investment horizon is 20 years for the combination of Stage One and Stage Two.

The Value 2-Stage, Value Range 2-Stage, and Return 2-Stage investment models allow you to specify the number of years in Stage One (from 3 to 10) and in Stage Two (from 3 to 20).

The terminal value or selling price at the end of the second stage is automatically discounted to the base year (year-zero of the forecast), as are each of the stage-one annual cash flows and the stage-two annual cash flows.

Thus, the two-stage models are a convenient way to incorporate the consensus estimates of analysts who follow a particular stock. These so-called long-term forecasts usually cover the next 3 years to 5 years, but they also generally incorporate a sales bias or sell-side distortion.

When the ratio of analysts' Buy recommendations to Sell recommendations is 100-to-1 or higher, then the corresponding growth estimates can be expected to be overly optimistic. It might be more instructive to learn the analyst's rationale behind the highest growth estimate, the lowest growth estimate, and the middle growth estimate. Then you can decide which rationale you most agree with, if any, to help determine your own growth estimate.

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