I don’t follow Damodaran. Do you mean this? Musings on Markets: A Do-it-yourself (DIY) Valuation of Tesla: Of Investment Regrets and Disagreements!
I don’t think that’s an indictment of DCF. Tesla is just a pretty unique company in a lot of ways. It looks like Damodaran sold at a split adjusted price around $43? I bet he wishes he held, but sometimes one makes mistakes. What is Buffett’s #1 rule, though?
As a counterpoint, lets look at Upstart, and My Portfolio at the End of Aug 2021 - maybe a DCF analysis wouldn’t have helped here, but UPST is down almost 90% from that post. We are trying to predict the future when investing, and that is intrinsically risky to the downside and upside.
DCF is a tool, not a strategy, and I disagree with you that they are worthless for high growth companies. Models are models, and GIGO applies. Let me extend my example from earlier. Say we have “company 5”, that sits around doing R&D for 5 years, then releases a blockbuster that creates a $500M annual profit invention that grows 10% annually after it debuts to the world. What is that worth?
DCF says:
| Company 5 | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| 0 | 0 | 0 | 0 | 0 | 500 | 550 | 605 | 665.5 | 732.05 | |
| 1 | 1.04 | 1.0816 | 1.124864 | 1.16985856 | 1.216652902 | 1.265319018 | 1.315931779 | 1.36856905 | 1.423311812 | |
| 0 | 0 | 0 | 0 | 0 | 410.9635534 | 434.6729892 | 459.750277 | 486.2743314 | 514.3286198 | 2305.989771 |
$2306 per share.
What if that company instead enjoys 2 years of success of that product, but in year 7 there is a disaster of some kind, and profit drops by 60% - but bounces back by $50M annual after that - and the discount rate goes to 1%?
| Company 5 | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| 0 | 0 | 0 | 0 | 0 | 500 | 550 | 100 | 150 | 200 | |
| 1 | 1.04 | 1.0816 | 1.124864 | 1.16985856 | 1.216652902 | 1.265319018 | 1.277972209 | 1.290751931 | 1.30365945 | |
| 0 | 0 | 0 | 0 | 0 | 410.9635534 | 434.6729892 | 78.24896294 | 116.2113311 | 153.4142985 | 1193.511135 |
$1193.
The company doesn’t disappear after 10 years, so many one wants to pay more. Maybe someone really likes a company and wants to pay a 20% premium.
What various net present value financial models give you is a framework to discuss a value quantitatively. If someone says a company should command a 10x revenue multiple, you ask them what there TAM is, what their terminal net margin rate is, and you can see if that valuation holds water at all. It doesn’t matter if the company is a transformational SaaS or sells tin buckets.