I realize that your DCF model for determining fair value is proprietary, but would you be willing to comment on the process in slightly more detail? Comparing your model to others, it appears to me that you give more front end weight the annual discounted income streams. Reply
While we rely on standard financial formulas rather than a custom or proprietary recipe, the ‘front-end weighting’ you are noticing primarily comes down to how we handle the decay of growth rates. Rather than assuming a company can maintain its current growth trajectory indefinitely—which often inflates the Terminal Value in traditional DCF models—we dynamically fade the growth rate over a five-year period. We start Year 1 using the company’s Forward EBITDA Growth. However, by Year 5, we force that growth rate to decay toward the long-term historical average of the stock’s industry group (specifically, by Year 5 the rate is weighted 80% to the industry average and only 20% to the stock’s initial growth). By aggressively reverting the growth rate to the industry mean and discounting it against the Weighted Average Cost of Capital (WACC), the model naturally prevents the Terminal Value from running away with the valuation. This inherently makes those more predictable, near-term annual cash flows carry a more significant weight in the final calculation. Regards Ken
Nicely done work here! I do notice that in your example there are different Terminal Growth Rates. A very small change in TGRs has a significant impact on valuation. What is the decision process on choice of that input, TGRs? Reply
Here is how Stock Rover determines and applies the Terminal Growth Rate in their Discounted Cash Flow (DCF) models: 1. Historical Industry Observations Over Subjective Predictions Instead of attempting to forecast a specific company’s growth rate into perpetuity (which can lead to massive valuation swings based on tiny adjustments, as you noted), Stock Rover uses historical observations of the stock’s industry. This helps normalize the growth rate to realistic, proven industry benchmarks rather than overly optimistic or pessimistic individual predictions. 2. The Decay Formula (Reversion to the Mean) Stock Rover dynamically adjusts the growth rate over the forecasted period so that it naturally transitions toward that long-term industry average: • Year 1: The model starts with the stock’s Forward EBITDA Growth (or the industry average if the specific stock’s data is unavailable). • Years 2 through 5: This initial growth rate decays steadily toward the long-term average of the stock’s industry group. • Year 5 and beyond: By the fifth year, the assumed growth rate is heavily weighted toward the industry baseline—specifically calculated as 80% based on the group/industry average and only 20% on the stock’s initial Forward EBITDA Growth. By systematically fading the initial company-specific growth rate into a historical industry average, Stock Rover’s DCF model creates a standardized, data-driven Terminal Growth Rate. This automated process minimizes the volatility and human bias often associated with manually picking a TGR. Regards, Ken
Are you able to back-test this process? If yes, is this something that a subscriber of the software could do? Thanks, Derek S. Reply
Stock Rover does not currently track historical Fair Value or Margin of Safety data, though this is something we may consider adding in a future release. Regards, Ken
