The Underpinnings of Discounted Cash flow Valuation
In discounted cash flow valuation, we try to estimate the intrinsic value of an asset based upon its fundamentals. What is intrinsic value? For lack of a better definition, consider it the value that would be attached to the firm by an all-knowing analyst, who not only knows the expected cash flows for the firm but also attaches the right discount rate(s) to these cash flows and values them with absolute precision.
Hopeless though the task of estimating intrinsic value may seem to be, especially when valuing young companies with substantial uncertainty about the future, we believe that these estimates can be different from the market prices attached to these companies. In other words, markets make mistakes.
Does that mean we believe that markets are inefficient? Not quite. While we assume that prices can deviate from intrinsic value, estimated based upon fundamentals, we also assume that the two will converge sooner rather than latter.
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10-04-2008, 12:21 AM
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