300 lines
11 KiB
Org Mode
300 lines
11 KiB
Org Mode
#+title: Section 11 | Lesson 65 - DCF (Discounted Cash Flow) Analysis
|
||
#+HTML_HEAD: <link rel="stylesheet" type="text/css" href="../_share/media/css/org-media-sass/categories/business.css" />
|
||
#+OPTIONS: H:6
|
||
|
||
* Links
|
||
- [[./../mba-main.org][TOC | Business]]
|
||
- [[https://www.udemy.com/course/an-entire-mba-in-1-courseaward-winning-business-school-prof/learn/lecture/4317198#overview][S12:L65 course video]]
|
||
|
||
|
||
* notes
|
||
** take the average of three valuations
|
||
- price / earnings
|
||
- price / sales
|
||
- DCF
|
||
** [[#dcf][Discounted Cash Flow (DCF)]]
|
||
- because cash flow is similar to net income for tech stocks it makes things easier [[#cashflow-diff][link 1]] [[#cashflow-diff-real][link 2]]
|
||
|
||
- DCF is the value of all future cash flows discounted today
|
||
*** how we do it
|
||
- assume we are going public in 2020
|
||
- need to look at cash flow for 2020-2025
|
||
- calculate WACC (cost of capital)
|
||
- calculate beta from the internet
|
||
- three companies similar to ours
|
||
- average it out
|
||
|
||
*** formulas
|
||
**** weighted average cost of capital
|
||
- \( \text{WACC} = \text{Cost of Equity} + \text{Cost of Debt} \)
|
||
|
||
- we subtract debt b/c it's a hi tech company
|
||
|
||
**** Cost of Equity Formula
|
||
|
||
\( \text{Cost of Equity} = r_f + (r_m - r_f) \cdot \beta \)
|
||
|
||
Where:
|
||
- \( r_f \) = Risk-free rate (government rate)
|
||
- theoretical rate of return on an investment with zero risk
|
||
- how much an investior would expect on a completely safe investment over a given time period
|
||
- usually based on yield of government bonds
|
||
- \( r_m \) = Stock market return
|
||
- expected or historical average annual return of a broad stock market index
|
||
- S&P 500
|
||
- TA-125
|
||
- MSCI World Index
|
||
- annual return (%) expected from the overall stock market
|
||
- \( \beta \) = Volatility (beta) of the company
|
||
- finanicial websites that list ϐ (beta)
|
||
- yahoo finance -> search for a stock -> under statistics -> see Beta
|
||
- google finance, morningstar, marketwatch
|
||
|
||
- beta measures how much a stock moves relative to the market
|
||
- you can calculate it
|
||
|
||
* definitions
|
||
** Discounted Cash Flow (DCF)
|
||
:PROPERTIES:
|
||
:CUSTOM_ID: dcf
|
||
:END:
|
||
|
||
*** What is DCF?
|
||
Discounted Cash Flow (DCF) is a financial valuation method used to estimate the *present value* of an investment or business based on its *expected future cash flows*.
|
||
|
||
The core idea: *money today is worth more than money tomorrow*, due to the time value of money. DCF discounts future expected cash flows back to their present value using a discount rate (usually the cost of capital).
|
||
|
||
*** Formula
|
||
#+BEGIN_SRC latex
|
||
\text{DCF} = \sum_{t=1}^{n} \frac{CF_t}{(1 + r)^t}
|
||
#+END_SRC
|
||
|
||
- \( CF_t \): Cash flow at time \( t \)
|
||
- \( r \): Discount rate (e.g., 10%)
|
||
- \( n \): Number of years or periods
|
||
|
||
*** Example
|
||
You're evaluating a business expected to generate the following cash flows:
|
||
|
||
- Year 1: $100,000
|
||
- Year 2: $110,000
|
||
- Year 3: $120,000
|
||
- Discount rate: 10%
|
||
|
||
#+BEGIN_SRC latex
|
||
\text{DCF} = \frac{100{,}000}{(1.10)^1} + \frac{110{,}000}{(1.10)^2} + \frac{120{,}000}{(1.10)^3}
|
||
= 90{,}909 + 90{,}909 + 90{,}163 ≈ \$272{,}000
|
||
#+END_SRC
|
||
|
||
*** When to Use DCF
|
||
- When valuing businesses with predictable cash flows
|
||
- To assess investment or project viability
|
||
- To compare multiple investment opportunities
|
||
|
||
*** Notes
|
||
- DCF can include a *terminal value* if the business continues beyond the forecast period
|
||
- Highly sensitive to discount rate and cash flow assumptions
|
||
|
||
** Difference Between Cash Flow and Net Income
|
||
:PROPERTIES:
|
||
:CUSTOM_ID: cashflow-diff
|
||
:END:
|
||
|
||
The difference between cash flow and net income lies in *timing* and *accounting method* — they measure different things.
|
||
|
||
*** ✅ Net Income
|
||
The company’s *profit* after all revenues and expenses are accounted for, based on accrual accounting.
|
||
|
||
- Appears on the income statement
|
||
- Includes non-cash items like depreciation and amortization
|
||
- Includes revenues earned and expenses incurred, even if no cash has changed hands yet
|
||
- Formula:
|
||
|
||
#+BEGIN_SRC text
|
||
Net Income = Revenue - Expenses (including non-cash and interest/taxes)
|
||
#+END_SRC
|
||
|
||
*** ✅ Cash Flow
|
||
The *actual cash* moving into and out of the business during a period.
|
||
|
||
- Appears on the cash flow statement
|
||
- Based on cash accounting
|
||
- Only counts real money in/out, regardless of when it was earned or incurred
|
||
- Includes operations, investing, and financing activities
|
||
- Formula (Operating Cash Flow):
|
||
|
||
#+BEGIN_SRC text
|
||
Cash Flow from Ops = Net Income
|
||
+ Non-cash expenses (e.g. depreciation)
|
||
- Changes in working capital
|
||
#+END_SRC
|
||
|
||
*** 🧠 Key Differences
|
||
|
||
| Feature | Net Income | Cash Flow |
|
||
|---------------------------------+---------------------------+----------------------------------|
|
||
| Basis | Accrual accounting | Cash accounting |
|
||
| Includes non-cash? | Yes (depreciation, etc.) | No |
|
||
| Timing of transactions | Matches earnings period | Based on actual cash movement |
|
||
| Found on | Income statement | Cash flow statement |
|
||
| Reflects profitability? | Yes | No, it reflects liquidity |
|
||
| Negative while other is positive?| Yes | Yes — e.g., due to non-cash charges |
|
||
|
||
*** 🔍 Example
|
||
- A company sells $10,000 of goods but hasn’t been paid yet.
|
||
- Net Income: Shows the $10,000 as revenue.
|
||
|
||
** Is net income more similar to cash flow in terms of a tech stock?
|
||
:PROPERTIES:
|
||
:CUSTOM_ID: cashflow-diff-real
|
||
:END:
|
||
|
||
That is, do we effectively consider it the same when doing evaluations for tech stocks as opposed to other industries?
|
||
|
||
Great question — and the answer is *no*, net income is not considered equivalent to cash flow, even for tech stocks — though the relationship can be closer or more misleading depending on the business model.
|
||
|
||
*** ✅ Tech Stocks Often Emphasize Free Cash Flow (FCF) More Than Net Income
|
||
|
||
Why?
|
||
|
||
- Tech companies (especially SaaS) tend to have:
|
||
- High non-cash expenses (like stock-based compensation and depreciation of capitalized R&D)
|
||
- Deferred revenue (prepaid subscriptions)
|
||
- Low capital expenditure needs
|
||
|
||
These factors can cause net income to look worse than actual cash performance.
|
||
|
||
So analysts often disregard net income in favor of:
|
||
|
||
- Operating cash flow
|
||
- Free cash flow (FCF):
|
||
|
||
#+BEGIN_SRC latex
|
||
\text{FCF} = \text{Operating Cash Flow} - \text{CapEx}
|
||
#+END_SRC
|
||
|
||
*** 📊 Example: Tech Company X
|
||
|
||
| Metric | Value |
|
||
|---------------------------+---------------|
|
||
| Net income | $5 million |
|
||
| Stock-based compensation | $10 million |
|
||
| Depreciation | $3 million |
|
||
| CapEx [[#capex][(link)]] | $2 million |
|
||
| Operating cash flow | $18 million |
|
||
| Free cash flow | $16 million |
|
||
|
||
➡️ The net income looks modest, but the free cash flow is much stronger — this is what investors in tech tend to value more.
|
||
|
||
*** 🔁 Compare with Other Industries
|
||
|
||
| Industry | Preferred Metric | Why |
|
||
|--------------+----------------------------+----------------------------------------|
|
||
| Tech (SaaS) | Free Cash Flow | Low cape, high non-cash costs |
|
||
| Utilities | Net Income + Dividends | Stable earnings, regulated cash flow |
|
||
| Oil & Gas | EBITDA / FCF | High depreciation, volatile capex |
|
||
| Banks | Net Income (GAAP adjusted) | Highly regulated balance sheets |
|
||
|
||
*** 🧠 Conclusion
|
||
|
||
- No, net income ≠ cash flow for tech stocks
|
||
- In fact, net income may understate performance due to:
|
||
- High non-cash expenses (e.g., stock comp)
|
||
- Accounting rules around R&D and subscriptions
|
||
- DCF models for tech should focus on FCF or adjusted EBITDA, not just net income - Cash Flow: $0 until cash is actually received.
|
||
|
||
** CapEx – Capital Expenditures
|
||
:PROPERTIES:
|
||
:CUSTOM_ID: capex
|
||
:END:
|
||
|
||
*** What is CapEx?
|
||
CapEx stands for *Capital Expenditures* — it refers to money a company spends to acquire, upgrade, or maintain physical assets such as:
|
||
|
||
- Equipment
|
||
- Buildings
|
||
- Vehicles
|
||
- Technology infrastructure
|
||
- Property
|
||
|
||
*** In Plain Terms
|
||
CapEx is money spent on things that last more than one year — unlike operating expenses (OpEx), which are day-to-day costs like rent, salaries, or utilities.
|
||
|
||
*** Accounting Treatment
|
||
- CapEx is not expensed all at once on the income statement.
|
||
- It’s capitalized — added to the balance sheet as an asset — and then depreciated over time.
|
||
|
||
*** Examples
|
||
|
||
| Action | CapEx? |
|
||
|-----------------------+----------------|
|
||
| Buying servers | ✅ Yes |
|
||
| Repainting the office | ❌ No (OpEx) |
|
||
| Building a data center| ✅ Yes |
|
||
| Paying engineers | ❌ No (OpEx) |
|
||
|
||
*** CapEx in Valuation
|
||
- Important in Free Cash Flow (FCF) calculations:
|
||
|
||
#+BEGIN_SRC latex
|
||
\text{FCF} = \text{Operating Cash Flow} - \text{CapEx}
|
||
#+END_SRC
|
||
|
||
- High-growth tech companies often have low CapEx, which boosts FCF and valuation.
|
||
- Asset-heavy companies (like telecom, energy, or manufacturing) have high CapEx, reducing FCF.
|
||
|
||
** EBITDA - Earnings Before Interest, Taxes, Depreciation, and Amortization
|
||
|
||
*** What is EBITDA?
|
||
EBITDA is a measure of a company’s core operational profitability. It strips out the effects of financing decisions, tax environments, and non-cash accounting items like depreciation and amortization.
|
||
|
||
*** Purpose
|
||
EBITDA is commonly used to:
|
||
- Assess a company’s operating performance
|
||
- Compare companies across industries
|
||
- Approximate cash flow (roughly)
|
||
|
||
*** Formula
|
||
|
||
From Net Income:
|
||
#+BEGIN_SRC text
|
||
EBITDA = Net Income
|
||
+ Interest
|
||
+ Taxes
|
||
+ Depreciation
|
||
+ Amortization
|
||
#+END_SRC
|
||
|
||
From Operating Income (EBIT):
|
||
#+BEGIN_SRC text
|
||
EBITDA = Operating Income
|
||
+ Depreciation
|
||
+ Amortization
|
||
#+END_SRC
|
||
|
||
*** Why Use EBITDA?
|
||
|
||
| Benefit | Explanation |
|
||
|--------------------------+----------------------------------------------------|
|
||
| Strip out accounting noise | Removes non-cash charges like depreciation |
|
||
| Cross-industry comparison | Ignores capital structure and tax regime effects |
|
||
| Cash flow proxy | Gives a rough estimate of operating cash flow |
|
||
|
||
*** Cautions
|
||
- EBITDA is *not* actual cash flow.
|
||
- It ignores capital expenditures and changes in working capital.
|
||
- It can be used to obscure poor net income performance.
|
||
- Not suitable for asset-heavy businesses as it omits large CapEx burdens.
|
||
|
||
*** Example
|
||
Suppose a company reports:
|
||
|
||
- Net Income: $1,000,000
|
||
- Interest: $500,000
|
||
- Taxes: $400,000
|
||
- Depreciation: $300,000
|
||
- Amortization: $200,000
|
||
|
||
#+BEGIN_SRC text
|
||
EBITDA = 1,000,000 + 500,000 + 400,000 + 300,000 + 200,000 = $2,400,000
|
||
#+END_SRC
|