" What sets pricing? Supply and demand. Mood and momentum. What sets value? Cash flows, growth and risk. Can the two give you different results? Absolutely. "
The quote above come from the Google Talks by Damodaran, the King of Valuation.
Valuation is subjective. I find DCF's and any other technical measures bring out the worst heuristics and biases that investors face. Searching for a WACC or cost of equity is easy to use a round number such as 10%, and assumptions for growth can be backed out of your perceived (the price you aim the valuation exercise to give you) target price.
I've made my valuation process this 'simple': concentrate on finding a narrative for growth, risk and cash flows. The story should give logical reasoning for all assumptions, for example how much does a company need to reinvest to earn these rates of growth and cash flows? I am now in the process of making a checklist that will help me build this narrative.
DCF comes in two parts: the cash flow, and the discount rate. Risk, growth and cash flow. Tell a narrative to get your assumptions for these three factors that drive the valuation. Find ranges of assumptions based on bounded rationality. Use 'laws of the universe' when building a narrative, i.e. an operational margin of 50% is not sustainable in the long term and doesn't come for free.
Building a narrative reminded me of Munger's quote:
'People calculate too much and think too little'
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