What about research / development and advertisement? It also a kind of "investment" to generate more revenue and higher margins but it is not included within the Capex number.
1:14:40 why cant negative risk free rate and 2% growth rate co-exist for a mature company in Euro zone? how is inflation rate embedded in risk free rate if both are negative?
Risk free rates are decided by the currency in which the valuation is done. There might be a company which generates majority of revenues from another market, in which case a higher growth rate (2 percent) would be possible (depending on the market and the product). A negative risk free rate might mean, that people are literally ready to pay for having a safe investment. This might indicate a extreme risk averse market with very low demand. Growth in such markets (unless you are in an industry providing essentials) might be difficult to achieve. Negative risk free rate also means the sovereign bonds are worthless and interest rates are negative which means central banks have no mechanism to revive demand clearly indicating a recession . You cannot have growth during recession. These need to be factored in your valuation. Everything depends on your story about your company. To answer your second question, a negative inflation might most probably mean a negative risk free rate but that doesn't mean your cost of capital would be negative. It might be significantly higher.
Hi Professor, I Understand how the discount rate changes with time. But, how to incorporate this in the DCF. If we are using different discount rates for every year, the denominator would look a lot messy. Do you take the Geo-Mean of all the different discount rates and use it as a single number?
We are anyways doing the calculation only for 10 years and assuming that the company will grow at economy's growth rate post that (terminal value) . I think it's better to factor in changes for each period block (maybe based on the stage of the company). Assuming it's a growth startup currently existing only in one market, the changes in its debt mix, growth, revenue mix, change in business and operating leverage might significantly change the cost of capital significantly as the company matures. Geometric mean won't give accurate results then. It's better to factor these accurately, given that we are doing it only for smaller time period. Also like what professor explained, impact of corona on cost of capital also needs to be factored. Your cost of capital might be very low now due to low risk free rates but that might not be sustainable in future. Using a median rate would skew your computation. Hope this helps.
I dare to disagree with Prof Damodaran's assumption on mature companies's default growth path at overall economy's growth rate after year 10. I think a more realistic scenario is to assume these companies, with a few exceptions in consumer staples sector, will eventually lose/wear out their competitive advantages after a decade, therefore the default path is either slow death (negative growth rate) , quick death (desperate and reckless risk-taking reforms/acquisitions taken by over-ambitious management which kills the company), or revive into a new company (apple after 1997, microsft after 2015). However the 3rd case is extremely rare.
Hello sir, I have doubt. how to normalize the negative free cash flow of firm in valuation? If company have negative free cash of firm for past 5 years how to do intrinsic valuation. Kindly give me solution.👍
Adjust one time non recurring expenses and assume a growth rate based on stage of the company. Valuation is based on future cash flows and negative cash flows in the past though being a great indicator does not mean the company will never make money. Over time factors like recall value, low capital investment, low fixed cost, debt, diversification, pricing power and monopoly might play out and the company can start making money. Our job is to build a story for the company based on the past and ensure that the assumptions we make do not contradict each other. I would recommend you to see through sir's valuation of uber to understand better.
Sir, in many indian Companies, the reinvestment rate is more than 90% on Return of 18% and exceeding the KE many times and defeating the Gordon Growth Formula to get the output. Plz share your inputs or reference video. Many thanks in advance.
It's not necessary to blindly consider reinvestment rate* historical ROE as the growth rate. ROE is the historical accounting derivative which might not continue in the future. The high value might also be because of buy backs or one time provision reversals. Take for example a company called viniti organic. The company has a very high ROE primarily because there was a supply constraint in one of its products last year leading it to become the sole supplier. The thing we need to check is whether the company is able to consistently generate new orders with the sme margin (which management in the commentary have told is not possible). So long story short, it's better to consider valuation as a story telling exercise than a formula based excel sheet. If it is a growing startup, the ROE might be high, but the beta will also be high. We also need to recheck if the cost of equity has all components correctly captured. Hope this helps you CA Prashanth
Hi Prof. Been following your teaching actively.
Can anyone explain the discrepency at 5:53 (NI growth will be higher than OI growth) and it was mentioned in Applied CF book it was the opposite.
He is the "Eminem" of finance.....
😂👍
What about research / development and advertisement? It also a kind of "investment" to generate more revenue and higher margins but it is not included within the Capex number.
1:14:40 why cant negative risk free rate and 2% growth rate co-exist for a mature company in Euro zone? how is inflation rate embedded in risk free rate if both are negative?
Risk free rates are decided by the currency in which the valuation is done. There might be a company which generates majority of revenues from another market, in which case a higher growth rate (2 percent) would be possible (depending on the market and the product). A negative risk free rate might mean, that people are literally ready to pay for having a safe investment. This might indicate a extreme risk averse market with very low demand. Growth in such markets (unless you are in an industry providing essentials) might be difficult to achieve.
Negative risk free rate also means the sovereign bonds are worthless and interest rates are negative which means central banks have no mechanism to revive demand clearly indicating a recession . You cannot have growth during recession.
These need to be factored in your valuation. Everything depends on your story about your company.
To answer your second question, a negative inflation might most probably mean a negative risk free rate but that doesn't mean your cost of capital would be negative. It might be significantly higher.
@@prashanthparthasarathy9603 Thank you very much for the input.
I take free cash flow to firm growth rate as growth rate.(or revanue growth rate).
Hi Professor, I Understand how the discount rate changes with time. But, how to incorporate this in the DCF. If we are using different discount rates for every year, the denominator would look a lot messy. Do you take the Geo-Mean of all the different discount rates and use it as a single number?
Sid Use a different discount factor by period
We are anyways doing the calculation only for 10 years and assuming that the company will grow at economy's growth rate post that (terminal value) . I think it's better to factor in changes for each period block (maybe based on the stage of the company). Assuming it's a growth startup currently existing only in one market, the changes in its debt mix, growth, revenue mix, change in business and operating leverage might significantly change the cost of capital significantly as the company matures. Geometric mean won't give accurate results then. It's better to factor these accurately, given that we are doing it only for smaller time period.
Also like what professor explained, impact of corona on cost of capital also needs to be factored. Your cost of capital might be very low now due to low risk free rates but that might not be sustainable in future. Using a median rate would skew your computation.
Hope this helps.
I dare to disagree with Prof Damodaran's assumption on mature companies's default growth path at overall economy's growth rate after year 10. I think a more realistic scenario is to assume these companies, with a few exceptions in consumer staples sector, will eventually lose/wear out their competitive advantages after a decade, therefore the default path is either slow death (negative growth rate) , quick death (desperate and reckless risk-taking reforms/acquisitions taken by over-ambitious management which kills the company), or revive into a new company (apple after 1997, microsft after 2015). However the 3rd case is extremely rare.
yes I use a negative maturity after ten years as well, as does Martin Shkreli ;)
Hello sir, I have doubt. how to normalize the negative free cash flow of firm in valuation? If company have negative free cash of firm for past 5 years how to do intrinsic valuation. Kindly give me solution.👍
Adjust one time non recurring expenses and assume a growth rate based on stage of the company. Valuation is based on future cash flows and negative cash flows in the past though being a great indicator does not mean the company will never make money. Over time factors like recall value, low capital investment, low fixed cost, debt, diversification, pricing power and monopoly might play out and the company can start making money. Our job is to build a story for the company based on the past and ensure that the assumptions we make do not contradict each other. I would recommend you to see through sir's valuation of uber to understand better.
Sir, in many indian Companies, the reinvestment rate is more than 90% on Return of 18% and exceeding the KE many times and defeating the Gordon Growth Formula to get the output. Plz share your inputs or reference video. Many thanks in advance.
It's not necessary to blindly consider reinvestment rate* historical ROE as the growth rate. ROE is the historical accounting derivative which might not continue in the future. The high value might also be because of buy backs or one time provision reversals. Take for example a company called viniti organic. The company has a very high ROE primarily because there was a supply constraint in one of its products last year leading it to become the sole supplier. The thing we need to check is whether the company is able to consistently generate new orders with the sme margin (which management in the commentary have told is not possible).
So long story short, it's better to consider valuation as a story telling exercise than a formula based excel sheet. If it is a growing startup, the ROE might be high, but the beta will also be high. We also need to recheck if the cost of equity has all components correctly captured.
Hope this helps you
CA Prashanth
52:45 What is the noise?