Posted: 22/Feb/2009 at 9:31pm
Originally posted by kanaka_basi
Originally posted by kannanravi1
Discount rate is typically what you think you should earn for taking the risk of owning stocks. Typically many fund managers add a risk premium over the treasury bond rates (treasury rates are thought to be zero risk). Eg: If treasury rates are 5%, some may think that 10% should be the risk adjusted rate. Buffett always goes by the treasury rates because he believes that his picks have zero risk! So, I guess one has to find his own comfortable rate.
PS: Any suggestions about how wrong/ right this method is??
I saw this link http://www.moneychimp.com/articles/valuation/buffett_calc.htm which uses the discount rate as an opportunity cost of not investing in the least riskiest of asset classes (treasuries).
I thought that the expected confidence percentage (or probability that the earnings growth would be met) and the fact that my opportunity cost would be the treasury rate gave me the worst case scenario in trying to find the intrinsic value of the stock... and also the assumption that the compnay would grow only 5 years into the future...
I too use the very same link for my DCF calcs!! Good to see I am not alone! I typically use a confidence margin ranging from 50% to 75% (for companies with extremely strong moat I use 75%). I use the opportunity cost as the treasury rate (I don't track the rates religiously but use 6 to 8%). I also predict growth only for 5 years and love to get stocks with no growth priced in. Even if I assume growth I try to keep at or below the GDP growth rates. Don't know if this gives me worst case scenarios but hopefully I am being conservative enough so that I have cushions for any mistakes in my valuation. Also personally I think that the best way to be conservative and risk-free is through buying companies with significant moats. This is a qualitative factor though unfortunately. Buffett once stated that he uses risk-free treasury rates because he believes that the companies he buys in are as stable and risk free as a treasury bill!!