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ValuFocus Investing: A Cash-Loving Contrarian Way to Invest in Stocks by William F. Mahoney, Rawley Thomas

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Chapter 30

Comparing Our Model against Three Popular DDMs

Many investors, of course, are familiar with discounted cash flow principles and models. As already stated, DCF is generally accepted standard practice for valuing most any producing asset. The model is used to estimate the asset's ability to generate a certain amount of cash over a designated period, determine a level of fade and terminal value, and then discount that result back to its present value through use of a reasonable discount rate.

Over time, investors and scholars have developed a plethora of DCF models. They are widely used in stock selection, although still falling far behind in popularity to the many earnings-driven statistical analysis models. Most of the latter fall into the multifactor group. Among the most popular of the cash-driven variety are dividend discount models (DDMs).

We decided to compare our LifeCycle Returns (LCRT) free cash flow model against three popular dividend discount models. We don't hesitate for a minute to say that our goal is to prove empirically the significant advantages of the more sophisticated free cash flow methodology.

We believe our studies do exactly that, primarily by showing the limitations of the DDMs, especially in delivering on the previously stated four principles of an effective model, while demonstrating the abilities of our model.

Dividend discount models bring important advantages in general to investors. The models are commonly accepted and extensively used. ...

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