Discounted Cash Flow Valuation Advantages and Pitfalls

Question: Discuss about the Discounted Cash Flow Valuation for Advantages and Pitfalls. Answer: Introduction: Calling a fund manager skilled is a rare phenomena. However, John Whiteman, the senior portfolio manager of AMP Henderson can be called as skilled with regards stock picking He as a portfolio manager does not look at the performance of a stock from a 2D perspective, rather looks at the stocks from a 3D perspective wherein not only quantitative but also qualitative analysis is done. Analysing the industry to which a company belongs is one of the feature of a skilled portfolio manager. John Whiteman has a growth approach and some fund managers who think that investing in companies whose prices will rise in future thus pulling the share prices towards upward direction are termed as skilled like John (Hoyle, 2003). He as a fund manager does not concentrate only on one sector but has ventured into banking, transportation, retail and food segment while forming the AMP Henderson Capital portfolio. Further since John Whiteman had confidence in his decisions and was aware of what steps he is taking, he is termed as skilled in the true sense. Further to this the fund managers use the discounted cash flow method while picking stocks as it helps them to make a more accurate analysis of the future performance of the stocks. DCF is a method of valuation which discounts the future cash flows from a particular stock at its present value. The method is complex yet DCF enables to give a more accurate return from ones investment after taking into account the time value of money. The said method offers a more transparent tool in the hands of the fund managers in accessing a companys performance. Although developing the DCF model is complex yet the shareholders and other investors get a clearer view with regards the factors that would drive the price of the shares of the company in future, the growth in the companys earnings, how efficiently the capital is being utilised, what is the cost of the capital and in what time gap will the company start growing (McClure, 2016). Another very crucial point to note while adapting this model f or computing the share value of a company is that manipulation by varying accounting practices is difficult. Another very striking part of this model is that it is often used a s a reality check by the fund managers. It provides a authentic value of the firm unlike the other methods such as calculating the P/E ratios. However this does not mean that the fund managers should depend solely on the DCF model. It simply means that they should give more weightage and trust to this mode as it enables to provide an fundamental value to the stocks in discussion. The DCF model uses free cash flows which is free from any kind of manipulative figures (Stephen, 2014). Lastly it also offers the fund managers to include major changes in the strategy formed by the company into the model thus giving it a clearer picture. Thus it is the best model to be used by the fund managers. References: Hoyle, S. (2003). Pick out the cash flow. Retrieved from https://www.theage.com.au/articles/2003/09/26/1064083189607.html?from=storyrhs McClure, B. (2016). DCF Analysis: Pros and Cons of DCF. Retrieved from https://www.investopedia.com/university/dcf/dcf5.asp Stephen,E. (2014). Discounted Cash Flow Valuation: Advantages and Pitfalls. Retrieved fromhttps://www.firmex.com/thedealroom/discounted-cash-flow-valuation-advantages-pitfalls/