Valuation and Growth

ADM 4350 Miwako Nitani

Overview
DCF Overview Key Inputs to DCF Valuation: Estimating Growth and
FCFs
1. 2. 3.

What is Growth? Really? Where does Growth Come from? Ways of Estimating Growth
Looking at the Past and What Others are Estimating Looking at Fundamentals

Closure in Valuation: Estimating Terminal Value A Quick Review: How to Calculate FCF Beyond Inputs: Choosing and Using the Right Model Discussion

DCF Overview

Discounted Cash Flow Valuation

What is it?

Philosophical Basis:

In discounted cash flow valuation, the value of an asset is the present value of the expected cash flows on the asset. CFt Recall:
V0
t 1

(1 r ) t

Every asset has an intrinsic value that can be estimated, based upon its characteristics in terms of cash flows, growth and risk.

Appropriate for:

Discounted cash flow valuation is geared for assets that derive their value from the cash flows that they are expected to generate - most businesses and financial assets fall into this category.
To use discounted cash flow valuation, you need

Information Needed:

to estimate the life of the asset to estimate the cash flows during the life of the asset to estimate the discount rate to apply to these cash flows to get present value

The inputs needed for all discounted cash flow models - cash flows, discount rates and asset life - are the same, though the ease with which they can be estimated may vary from asset to asset.

DCF and Efficient Market Hypothesis

When we use DCF, we are assuming that:

Markets make mistakes (market prices can deviate from intrinsic values) We can estimate intrinsic value and, by comparing the intrinsic value to the market value, was can find under-or overvalued assets. Market prices will revert back to intrinsic value sooner or later - this is why a long time horizon is a pre-requisite.

In an attempt to find out under- or overvalued assets by valuation, you are

assuming market inefficiency.

Recall the semi-strong form of market efficiency.

When you are assuming that market will correct prices themselves, you are

assuming market efficiency. For the market to be efficient, investors who believe that the market is not efficient are necessary. Transactions made by those investors, who disagree with the current market prices, revert the price back to its intrinsic value.

Approaches to valuation: DCF

1. 2.

Value = future expected cash flows discounted at a rate that reflects the riskiness of the cash flows
Analyze the company its current and historical states. Calculate the relevant discount rate (often the cost of capital)

Often use the historical data

Length of growth period before the company enters the stable growth phase, or terminates its operation Growth rate for each of the years before the stable phase/termination

3.

Estimate the nature of the future growth

4.

5.

Based on the growth estimation, determine the free cash flow to the firm for each of the years before stable phase/termination Calculate PV of the cash flow for each of the years before stable phase/termination, and sum them up

usually involves creation of proforma financial statement.

Approaches to valuation: DCF

6.

Calculate the PV of the terminal value, which is either:

the PV of liquidation value if you assume the company terminates in the future, or the PV of the FCF generated during the stable phase

7.

8.

9.

and add it to the sum of the PV of the FCF calculated in step 5. Subtract the value of debt, other obligations. Add the value of excess assets (what can be sold without affecting projected cash flows). Examples: undeveloped land; excess cash or equivalent; portfolio of unused patents. Divide it by the number of shares outstanding.
Based on those, future cash flows are estimated

As we see, key inputs are:

Nature of future growth With this, future cash flows are discounted back to the present. Terminal value Discount rate

Key Inputs to DCF Valuation: Estimating Growth and FCFs

What is Growth? Really? Where does Growth Come from? Ways of Estimating Growth

Looking at the Past and What Others are Estimating Looking at Fundamentals

What is Growth? Really?

180,000

A reasonably well-known Canadian company

Total Revenue

160,000

140,000

120,000

100,000

80,000

60,000

40,000

20,000

0 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

Ballard Power Systems

50,000 180,000

160,000 0 140,000

-50,000

120,000

100,000 -100,000 80,000

-150,000

60,000

40,000 -200,000 20,000

-250,000 1996 1997 1998 1999 Total Revenue 2000 2001 2002 2003 2004 2005

Net Income Avail for Common

Total Revenues (000)

Net Income (000)

Ballard Power Systems

50,000 180,000

160,000 0 140,000

-50,000

120,000

100,000 -100,000

Can we reasonably expect dividends to grow? Never had earnings!

80,000

-150,000

60,000

40,000 -200,000 20,000

-250,000 1996 1997 1998 1999 Total Revenue 2000 2001 2002 2003 2004 2005

Net Income Avail for Common

Total Revenues (000)

Net Income (000)

If growth is not increased sales revenues, what is growth?

Ways of achieving a growth objective

Growth = Increasing the value of the firm Two categories of growth:
Organic Growth
growth from within

Growth by acquisition
growth from outside the firm

Where does Growth Come from?

Organic Growth Comes from

Where do positive NPV projects come from?

Economies of scale Cost advantages Capital requirements Product differentiation Access to distribution channels Legal & regulatory barriers

Organic Growth Comes from

What can management do?

Economies of scale

Maintain economies of scale by choosing products to produce (BIC) Nurture cost advantages (SABRE) Undertake strategies that increase the cost of entry (MICROSOFT) Branding, name recognition, customer service & reputation, advertising (IPOD)

Cost advantages Capital requirements Product differentiation Access to distribution channels

Nurture markets in which the firms differential advantage is greatest (exporting, segmentation), establish unique channels (AVON)
Employ patents, non-competition clauses, etc. (PHARMACEUTICALS, BIOTECHNOLOGY)

Legal & regulatory barriers

Organic Growth and Competition

What happens when a firm has a growth opportunity in
a competitive environment?

In a competitive marketplace, the existence of excess returns (positive NPV opportunities!) acts as a magnet

Draws competitors who undertake similar investments

(hence the need for barriers to entry!)

In time, then, excess returns dissipate, how long depends on:

Ease with which competitors can enter the market with close substitutes Magnitude of the differential advantage that the firm with good projects might possess

Industry Life Cycle

Shake out!

What about Growth by Acquisition

Consensus from Finance Research

Shareholders of target firms gain

No clear-cut about acquiring firms

It seems that shareholders of some acquiring firms gain, others lose

Why grow by acquisition?

Operating or financial synergy Take over poorly managed firms and change management
We will see more on acquisitions later

Ways of Estimating Growth

Looking at Past Looking at what others are estimating Looking at Fundamentals What I personally do

Ways of Estimating Growth

Look at the past

The historical growth is usually a good starting point for growth estimation Analysts estimate growth in earnings per share for many firms. It is useful to know what their estimates are. But do not blindly trust them always state what YOU think! Ultimately, all growth in earnings can be traced to two fundamentals A firms growth is ultimately determined by how much the firm is investing in new projects, and what returns these projects are making for the firm.

Look at what others are estimating

Look at fundamentals

Looking at the Past and What Others are Estimating

Historical Growth in EPS

Historical growth rates can be estimated in a number of
different ways

Arithmetic versus Geometric Averages

Two estimates can be very different, especially for firms with volatile earnings. e.g., trends Some use more sophisticated models:

Simple Regression Models

Time Series: ARIMA, SARIMA, etc.

How to treat negative earnings?

Historical Growth in EPS

Historical growth rates can be sensitive to the period used
in the estimation

How long a historical period Arbitrary choice of start/stop dates MAKE SURE TO choose a period during which the fundamentals of the business is similar to the current ones

Historical growth in revenues is more useful number for

forecasting than historical growth in earnings.

Revenue growth tends to be more persistent and predictable than earnings growth Accounting choices have a far smaller effect on revenues than they do on earnings.

Historical Growth in EPS

Size effect

It is easier for a firm with $10 million in earnings to generate a 50% growth than it is for a firm with $500 million in earnings. It becomes harder for firms to sustain high growth rates as they become large past growth rates for firms that have grown dramatically in size may be difficult to sustain in the future.

Past growth is more unreliable indicator of future growth for smaller

firms due to negative earnings, volatile growth rates, rapid change

Focus on revenue growth, rather than earnings Look at growth each year, rather than average Use historical growth rates as the basis for projections only in the near future (next year or two) - technologies changes rapidly Consider historical growth in the overall industry and in other firms there

You may find a pattern of growth shared by firms in the industry

A big task for small and growing firms is to handle growth

Analyst Forecasts of Growth

While the job of an analyst is to find under- and overvalued stocks in the sectors that they follow, a significant proportion of an analysts time is spent forecasting earnings per share.

Most of this time, in turn, is spent forecasting earnings per share in the next earnings report.

That is, did the company meet its stated earnings target? If not, why not? Missing target sends negative message to the market.

While many analysts forecast expected growth in earnings per share over the next 5 years, the analysis and information that goes into this estimate is (generally) far more limited.

Analyst forecasts of earnings per share and expected

growth are widely disseminated, at least for traded companies.

How good are analysts at forecasting growth?

Studies show that analysts forecasts of EPS tend to be closer to the
actual EPS than simple time series models, but the differences tend to be small
Study Collins & Hopwood Brown & Rozeff Fried & Givoly

Data Source Value Line Forecasts Value Line Forecasts Earnings Forecaster

Analyst Forecast Error 31.7% 28.4% 16.4%

Time Series Model 34.1% 32.2% 19.8%

The advantage that analysts have over time series models

Errors tend to decrease with the forecast period (next quarter versus 5 years) Errors tend to be greater for larger firms than for smaller firms Errors tend to be greater at the industry level than at the company level

Most analysts do not act independently and forecasts of growth (and

revisions thereof) tend to be highly correlated across analysts.

Propositions about Analyst Growth Rates

Proposition 1: There is far less private information and far more public
information in most analyst forecasts than is generally claimed. Proposition 2: The biggest source of private information for analysts remains the company itself, which might explain

why there are more buy recommendations than sell recommendations (information bias and the need to preserve sources) why there is such a high correlation across analysts forecasts and revisions why All-America analysts become better forecasters than other analysts after they are chosen to be part of the team.

Proposition 3: There is value to knowing what analysts are forecasting

as earnings growth for a firm. There is, however, danger when they agree too much (lemmingitis) and when they agree too little (in which case the information that they have is so noisy as to be useless).

What Weight should I assign to Analyst Forecasts?

Amount of recent information incorporated

Analysts forecasts incorporate more recent information than historical databased analysis. This advantage is greater for firms that have recently experienced significant changes in management or business conditions.

Number of analysts following the firm

In general, the larger the number of analysts following the firm, the more informative is their consensus forecast, and the greater should be the weight assigned to it.

Extent of disagreement across analysts

It is a useful measure of the reliability of the forecast. Standard deviation of analysts-forecasted earnings is correlated with risk. (Givoy and Lakonsihok, 1984) Disagreement among the newsletters is correlated with future realized volatility (Graham and Harvey, 1996).

What Weight should I assign to Analyst Forecasts?

Quality

Some analysts are better than others in predicting earnings. Future performance of a newsletter is related to its past performance (Jaffe and Mahoney, 1999) Stocks recommended by analysts who focus on a single industry outperform those recommended by analysts covering multiple industries (Desai, Liang, Singh, 2000).

DO NOT blindly follow consensus forecast

Successful valuation often lies in discovering inconsistency between analysts forecasts and the firms fundamentals.

Looking at Fundamentals

Expected Long Term Growth in EPS

Growth rate in net income
gt = (NIt NIt-1)/NIt-1 (1) Substitute (2), (3), and (4) to (1), and assuming ROE is unchanged (i.e., ROEt = ROEt-1 = ROE)
NIt = BVEt-1 ROEt Nit-1 = BVEt-2 ROEt-1 (2) (3)
Given the definition of ROE: ROE = NI/BVE

BVEt-1 = BVEt-2 + REt-1

(4)

We get:

BE = book value of equity, RE = retained earnings

gt = (Earnings Reinvestedt-1/ NIt-1) * ROE = Retention Ratio * ROE

Proposition 1: when a firm do not raise equity by issuing new

Note: since the firms do not raise equity by issuing new shares, the growth rate in net
income and the growth rate in EPS are the same.

shares, the expected growth rate in earnings for the firm cannot exceed its return on equity in the long term.

Estimating Expected Growth in EPS:

Example of ABN Amro

Current Return on Equity = 15.79% Current Retention Ratio = 1 - DPS/EPS

= 1 - 1.13/2.45 = 53.88%

If ABN Amro can maintain its current ROE and retention ratio, and if it does not raise equity by issuing shares, its expected growth in EPS will be:

= 0.5388 (15.79%) = 8.51%

Components of Growth Du Pont Identity

If g=Retention ratio X ROE, recall that:
ROE Net Income Stockholder ' s Equity

Net Income Total Assets ROE X Total Assets Stockholder ' s Equity
ROE Net Income Sales Total Assets X X Sales Total Assets Stockholde ' s Equity r

Profitability (Profit Margin)

Turnover Financial Leverage (Total Asset turnover) (Equity Multiplier)

Growth depends on: (1) operating efficiency, asset use efficiency, and
financial leverage.

Growth Patterns where is the companys current position?

Shake out!

Industry life cycle and company life cycle do not always coincide. There
are growing firms in a mature industry.

Is your firm a growing, or a mature firm? Is your firm in a growing or a mature industry?

Growth Patterns
A key assumption in all discounted cash flow models is the period
of high growth, and the pattern of growth during that period. In general, we can make one of the following four assumptions:

there is no high growth, in which case the firm is already in stable growth there will be high growth for a period, at the end of which the growth rate will drop to the stable growth rate (2-stage) there will be high growth for a period, at the end of which the growth rate will decline gradually to a stable growth rate (3-stage) Each year will have different margins and different growth rates (nstage)

Which Growth Pattern Should I use?

If your firm is

large and growing at a rate close to or less than growth rate of the economy, or constrained by regulation from growing at rate faster than the economy has the characteristics of a stable firm (average risk & reinvestment rates) Use a Stable Growth Model is large & growing at a moderate rate ( Overall growth rate + 10%) or has a single product & barriers to entry with a finite life (e.g. patents)

If your firm

Use a 2-Stage Growth Model

If your firm

is small and growing at a very high rate (> Overall growth rate + 10%) or has significant barriers to entry into the business has firm characteristics that are very different from the norm

Use a 3-Stage or n-stage Model The growth rate of a firm is driven by its fundamentals - how much it (re)invests and how high project returns are. As growth rates approach stability, the firm should be given the characteristics of a stable growth firm.

Growth and Firm Characteristics

Caveat: this is just a guideline DO NOT follow blindly!
Introduction Sales Volume Price Revenue Cost Earnings Ope. margin Low High Low High -ve High Maybe still -ve Rapid increase Stable growth Low +ve Growth Mature High Decline Decline Low Decline Counter-optimal decline Low

Risk
Capital Expenditure ROC Ope. history Comparable firms

High
High High limited A few Some (with large changes) Most with variety (competition intense - many new entries and shake-out!) Low, increase Mostly future growth

Low (average)
Low Low (close to WACC) Abundant Many

Increase
Little, if any Decline Substantial Decline

Assets Dividend payout ratio D/E (theory) Source of value

Intangible None Low Entirely future growth High High (industry average) More from existing assets

Tangible Decline Decline Entirely fro existing assets

Determinants of Growth Patterns

Size of the firm

Success usually makes a firm larger. As firms become larger, it becomes much more difficult for them to maintain high growth rates Small firms in (potentially) large market should have potential for high growth (at least in sales) over long period. Check the firms current market share, as well as the potential growth in the total market. Ultimately the growth rate of a firm will get close to that in the industry. But, Even large firms may be able to grow if the markets are growing (think Apple).

Size of, and growth rate in, the market

Determinants of Growth Patterns

Past and Current Growth

Momentum does matter. There is a correlation between current growth and future growth.

A firm growing at 30% currently probably has higher growth and a longer expected growth period than one now growing 10% a year. Firms that are earning high returns on capital in the current period are likely to sustain these excess returns for the next few years.

What is the pattern of growth? Is the firm is growing by acquisitions, R&D, and/or investments in marketing and distribution? For mature firms in mature industry, growth often comes from acquisitions (e.g., Cisco). Put weight on revenue growth more than income growth, since accounting rules can be used to pump up the latter. However, finally, note that past growth is not always a reliable indicator of future growth

Determinants of Growth Patterns

Barriers to entry and competitive advantages

how long growth will last and how high it will be?

What the barriers to entry are, how long they will stay up and how strong they will remain. What creates differential advantages? Marketing/operational strategy must be quantified.

We could assume Coca-Colas (or Amazons) high target margin and SG&A, due to its marketing effort to maintain/increase brand name and attract new customers.

Quality of management

Jack Welch at GE and Rpberto Goizueta at Coca-Cola

They are good examples of CEOs who made a profound difference in the growth of their firms.

The essence of value creating growth is the existence of competitive

advantages that are large and sustainable. The larger and more sustainable these advantages are, the longer the growth period can be. Ultimately, it is not growth that creates value but excess returns.

Closure in Valuation: Estimating Terminal Values

Discounted Cashflow Valuation

Getting Closure in Valuation

A publicly traded firm potentially has an infinite life. The value is
therefore the present value of cash flows forever.
Value = t = CFt t t = 1 (1+ r)

Since we cannot estimate cash flows forever, we estimate cash

flows for each of a certain period (the next several years, typically a growth period) and then estimate a terminal value, to capture the value at the end of the period:
t = N CF t + Terminal Value Value = N t (1 + r) t = 1 (1 + r)

Ways of Estimating Terminal Value

Most likely

Multiple approach: for example, if a firm has expected revenues of $6 billion 10 years from now and a value-to-sales multiple of 2, the estimated terminal value is 12 billion. The multiple has a huge effect on the final value so that the resultant estimate of the firm value becomes a relative value. Not recommended as a DCF should provide an estimate of intrinsic value, not relative value.

Stable Growth Model

While companies can maintain high growth rates for extended periods,

they will all approach stable growth at some point in time. So we usually estimate cash flows for each of the growth period, and when a firms cash flows grow at a constant rate forever, the present value of those cash flows can be written as:
Value = Expected Cash Flow Next Period / (r - g) where, r = Discount rate (Cost of Equity or Cost of Capital) g = Expected growth rate

This constant growth rate is called a stable

growth rate. When the firm approaches its stable growth phase, the valuation formula above can be used to estimate the terminal value of all cash flows beyond.

Limits on Stable Growth

The stable long term growth rate cannot exceed the
growth rate of the economy in which the firm operate. But it can be lower.

The economy is composed of high growth and stable growth firms, the growth rate of the latter will probably be lower than the growth rate of the economy. You are assuming that your firm will disappear over time (taking the firms declining period into consideration).

The stable growth rate can be negative.

Right choice when valuing firms in industries that are being phased out because of technological advances (manufactures of typewriters) change in consumers perception (tobacco producers), etc.

A Quick Review How to Calculate FCF

Measuring Cash Flow to the Firm

FCFF = EBIT(1 - tax rate) - (Capital Expenditures -Depreciation) Change in Noncash Net Working Capital

FCFF = cash flow generated by the firms assets. FCFF is split between debt holders (who get debt paid back out of FCFF) and equity holders who get whatever if left over (= Free Cash Flow to Equity holders, FCFE)

Note: 1. This FCFF does not incorporate the tax benefits due to interest payments, because the use of the after-tax cost of debt in the cost of capital already considers this benefit, and including it in the FCFF would double count it.

Measuring Cash Flow to the Equity Holders

FCFE = Net Income + Depreciation - Capital Expenditures - Change in Working Capital - (Principal repaid-New debt issued) - Preferred dividends = Free cash flow to equity FCFE = cash flow that accrues to the owners after assets have been maintained or expanded and after lenders have been repaid interest and capital. FCFF = FCFE + Interest expense (1-Tax) + Principal repayments New debt issued + Preferred dividends.

Fine Tuning Net Capital Expenditures

Net capital expenditures = capital expenditures depreciation. Growth requires investments, therefore:
NET CAP EX MUST BE >0 IF REAL GROWTH IS TO OCCUR

In general, the net capital expenditures will be a function of how fast a firm is growing or expecting to grow. High growth firms will have much higher net capital expenditures than low growth firms. Assumptions about net capital expenditures can therefore never be made independently of assumptions about growth in the future.

Same argument applies to working capital growth is typically

accompanied with an increase in working capital.

Some adjustments might be necessary

In finance, operating expenses should reflect only those expenses that create revenues in the current period. There are some expenses classified as operating expenses (from accounting point of view) that do not meet this criterion adjustments necessary.

1. R&D Expenditure

R & D and personal training expenses, of which benefits typically last

over multiple periods, should be included in capital expenditure.
Adjusted Net Capital Expenditures = Net Capital Expenditures + Current years R&D expenses - Amortization of Research Asset

EBIT and Book value of Equity must also be adjusted accordingly.

Adjusted book value of equity = book value of equity + value of the research asset Adjusted EBIT = EBIT + R&D expenses Amortization of research asset

Some adjustments might be necessary

2. Acquisitions of other firms

Acquisition of other firms should also be included in capital expenditure.

Adjusted Net Cap Ex = Net Capital Expenditures + Acquisitions of other firms Amortization of such acquisitions Two caveats: 1. Most firms do not do acquisitions every year. Hence, a normalized measure of acquisitions (looking at an average over time) should be used.

For example, the capital expenditure projections for a firm that makes an acquisition of $100 million approximately every fire years should include about $20 million, adjusted for inflation, every year.

2.

The best place to find acquisitions is in the statement of cash flows, usually categorized under other investment activities

Some adjustments might be necessary

3. Operating Lease
Consider two airline companies, A leases its aircrafts, and B borrows
money and buys aircrafts.
Airline A Revenue Operating expenses Lease payments Depreciation EBIT 11,000 9,975 750 275 Airline B 11,000 9,975 600 425

Discount future operating lease commitments back to the present at the

firms pretax cost of debt, add the resultant PV to debt.
Adjusted debt = Debt + PV of future lease commitment. Adjusted EBIT = EBIT + Operating lease expenses Depreciation on leased asset.

Beyond Inputs: Choosing and Using the Right Model

Discounted Cashflow Valuation

Summarizing the Inputs

In summary, at this stage in the process, we should have an
estimate of the

the current cash flows on the investment, either to equity investors (dividends or free cash flows to equity) or to the firm (cash flow to the firm) the current cost of equity and/or capital on the investment The pattern the growth is expected to follow the expected growth rate, based upon historical growth, analysts forecasts and/or fundamentals which cash flow to discount, FCFF or FCFE? which discount rate needs to be estimated, WACC or cost of equity?

The next step in the process is deciding

Which cash flow to discount?

Use Firm Valuation (PV @ WACC of FCFF)
(a) for firms that have leverage which is too high or too low, or expected to change the leverage over time. This is because in firm valuation debt payments and issues do not have to be factored in the cash flows and the discount rate (cost of capital) does not change dramatically over time. (b) for firms for which you have partial information on leverage (e.g., interest expenses or debt repayment schedule are missing..) (c) in all other cases, where you are more interested in valuing the firm than the equity.

Use Equity Valuation (PV @ Ke of FCFE)

(a) for firms which have stable leverage, and (b) if the final goal of valuation is the estimation of equity value (price per share)

Discussion

Advantages of DCF Valuation

Since DCF valuation, done right, is based upon an assets fundamentals,
it should be less exposed to market moods and perceptions.

If good investors buy businesses, rather than stocks (the Warren Buffett

No valuation model is ever immune from market moods. Discounted cash flow valuation is less exposed than relative valuation (multiples) to the ebbs and flows of the market. It is therefore much more likely to yield contrarian recommendations when markets get out of hand - sell when markets are booming and buy when markets are down.

approach invest in businesses you understand), discounted cash flow valuation is the right way to think about what you are getting when you buy an asset. DCF valuation forces you to think about the underlying characteristics of the firm, and understand its business. If nothing else, it brings you face to face with the assumptions you are making when you pay a given price for an asset.

Valuation is art, not science.

The process of valuation is almost as important as the product (the value that you estimate). As you consider the inputs you will use to value a firm, and examine the effect of changes in these inputs on value, you will understand the determinants of firm value.

Disadvantages of DCF valuation

Since it is an attempt to estimate intrinsic value, it requires far more inputs
and information than other valuation approaches These inputs and information are not only noisy (and difficult to estimate), but can be manipulated by the savvy analyst to provide the conclusion he or she wants. In an intrinsic valuation model, there is no guarantee that you will find under or over valued assets. Thus, it is possible in a DCF valuation model, to find every stock in a market to be over valued. This can be a problem for

equity research analysts, whose job it is to follow sectors and make recommendations on the most under and over valued stocks in that sector equity portfolio managers, who have to be fully (or close to fully) invested in equities

It does not take managerial options into consideration - Real Option

Approach.

When DCF Valuation works best

This approach is easiest to use for assets (firms):

Assets with clearly defined cash flows are easiest to value with DCF

whose cash flows are currently positive and Which can be estimated with some reliability for future periods (relatively mature firms), and where a proxy (YTM, required return from beta) for risk that can be used to obtain discount rates is available (public firms) .

models (apt building). Assets that generate a substantial portion of their value from the psychic pleasure they may give their owners - collectibles (e.g., art work) or even real estate - are much more difficult to value using DCF models. It works best for investors who either

have a long time horizon, allowing the market time to correct its valuation mistakes and for price to revert to true value or are capable of providing the catalyst needed to move price to value, as would be the case if you were an activist investor or a potential acquirer of the whole firm.

Investors with long time horizons are much more likely to succeed with DCF models, since they can give markets much more time to correct their mistakes.

Asset-based Valuation
In asset-based valuation, the value of a firm is the sum of
the market values of the assets (e.g., real estate, copyrights, etc.) if sold separately.

Value the individual assets owned by the firm ands sum them up to arrive the firm value. liquidation value. Replacement costs

Variations of asset-based valuation include:

However, asset based valuation requires that you use

either discounted cash flow or relative valuation models to value the individual assets. Consequently, this may be viewed as a subset of DCF or multiple-based approaches.