Chapter 5. The Dangers of DCF[5]

  • While the algebra of DCF is simple, neat and compelling, the implementation becomes a minefield of problems. The problems can be grouped into two categories: problems with estimating cash flows and problems with estimating discount rates.

  • One of the recurring themes of my research is that we just can't forecast. There isn't a shred of evidence to suggest that we can. This, of course, doesn't stop everyone from trying. Last year, Rui Antunes of our quant team looked at the short-term forecasting ability of analysts. The results aren't kind to my brethren. The average 24-month forecast error is around 94%, the average 12-month forecast error is around 45%. My work on long-term forecasts is no kinder to the analysts: they are no better at forecasting long-term growth than they are short-term growth.

  • Even if we ignore the inconvenient truth of our inability ...

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