BUD - Fools Duel

[buffett]

Thanks for the math breakdown. What led you to choose 15% and 12% for your discount rates? Do you use similar rates for other companies we've discussed (JCOM, GOOG, DNA, etc.)?

[AceHigh]

Discount rate is bond rate + risk. Bond rate is 6% and risk is 9% for BUD (9% is lowest). Newer companies get higher risk rates, so the other companies all have higher discount rates than BUD. Then all companies default to 12% after 10 years. This is the default discount rate for Quicken and I always take the default rates with this tool for discount rate.

[buffett]

I follow (and agree with) the framework but not the details. It seems like you might be double-counting some "risk," since the 10-year treasuries are yielding 4.5% but you're starting from a base of 6.0%.

Also, I don't get where the 9% comes from and why it is the "lowest."

For comparison purposes: the Longleaf folks discount at inflation+10%, Mr. Buffett has been using ~10% post-tax/~13% pre-tax as his floor discount rate in the current low-rate environment, and CAPM would say to use 4.5% plus some multiple of "risk premium" which I guess would work out to around 11% or so. So the 15%/12% thing to me seems excessive; to show others who may be following along how wide the swings of DCF can be...if you bring those down to 10%, the intrinsic value goes to $74 per share.

[AceHigh]

It's my favorite intrinsic value calculator, YMMV.


Found this in Quicken help:

• The bond rate: Your investment could grow risk-free at the bond rate. You'll need to beat this rate to make your investment worthwhile. Matching the bond rate also means automatically that your money will grow at or above the rate of inflation; if you fail to keep up with inflation, the purchasing power of your investment will dwindle over time.

• A "risk premium": You're probably looking to realize a certain percentage gain over and above the inflation and bond rates to make assuming the investment risk worth your while. The size of this risk premium is up to you.

Add the bond rate and risk premium together to arrive at a discount rate suitable to your investment expectations. Enter the discount rate into the text box. If you wish, you can leave the discount rate set to the default.

To calculate the default discount rate, Stock Evaluator uses a basic discount rate of 15% (assuming a 6% bond rate and 9% risk premium) for the first 10 years. After that, a lower discount rate of 12% is used. Assuming that younger companies pose a greater risk than older, more established companies, Stock Evaluator adjusts the default discount rate according to the age of the company (determined by the number of years of financial reports available) to allow for the attendant risk, as follows:
• For 9 or more years, no risk adjustment