For retail investors like us, do you all think the CAPM model is suitable to establish a discount rate/hurdle rate? (with the MAS short term bills used as the risk free rates) or do you all use other models, such as the fama-french model or even the market capitalisation rate?

Also, any thoughts about the gordon's dividend growth model vs the free cash flow approach for intrinsic valuation?

I personally tend towards the CAPM with the dividend growth model due to the simplicity in gathering of data points. Welcome any views and lets huat together!!

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3 people like this.
zayneng :

You can do weighted % on different model. It depends on the industry of the coy you analyzing. Must understand the industry before going into the companies financial. Using formula is easy, understanding where the companies stand in the industry is hard..once forecast wrong, whatever good formula you have will be useless.

marginofsafety :

Like many of the posters in here, I'm not a huge believer in CAPM either cos IIRC the formula assumes the market to be fully(?) efficient and obviously I don't think it's true.

My take on the hurdle rate is that it should at least be set at your targeted returns. Say you're aiming for 15% CAGR over the long term, why would you use a discount rate of 10%?

As for dividend model vs FCF, I prefer using FCF cos IMO the value of a company is determined by how much cash it generates over the long run, not by how much dividend it pays out. And using FCF paints a more accurate picture of that.

weishengchua :

Reply to @marginofsafety : hahaha yes, i think the view by almost all of the fund managers is that the efficient market hypothesis is solely for academics use and are not relevant when investing as well. https://www.youtube.com/watch?v=F0e87R90rcM

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mj0101 :

CAPM is kind of flawed but still useful, and I use market cap rates more now. Gordon's divi growth vs FCF depends on the company you are analysing. In the world world economy, new tech needs more a FCF approach

youkanglu :

Love seeing people talking about corporate finance stuff instead of ta and ups n downs plus gut feelings or maybe butt feelings.

J_Chou :

I think the best way for me personally is to use qualitative analysis look at upside downside and see if there are any positive catalysts within my time horizon for the investment. Then use DCF to determine the most conservative estimate and establish margin of safety.

I feel as retail investors given lack of resources we won't be able to get a DCF with pinpoint accuracy, forward P/E and comparable analysis are sometimes good enough if not better.

The type of DCF to use is dependent on individual company analysed. Consistent dividend payout use DDM, high growth companies use three stage FCF conglomerates with a few different major segments use SOTP. It's up to personal preference imo.

From personal experience I don't think CAPM is very useful...fama french is just a more in depth CAPM. I usually use damodarans list for equity risk premium and I have found that its not a good representative for the individual company I am assessing. I have some gripes with Mordern Portfolio Theory and beta also, I don't think beta is a good measurement of risk. But I have not learnt enough to do otherwise so I will just stick to the industry standard haha.

weishengchua :

Reply to @J_Chou : but i think for retail investors, it would be hard to construct an efficient frontier as well. regarding the modern portfolio theory, do you believe in diversification through an asset's correlation and ultimately, the portfolio variance? or do you think that diversifying based on industry sectors would be good enough. thanks for the writeup!

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bgting :

However, no matter how good a valuation method or model is, the assumptions and inputs are probably more important. Else it'll be garbage in, garbage out. Understand the underlying businesses first, then stay inside the circle of competence. :-)


Snorlax :

not a fan of CAPM. I am more towards macro economic as a top down approach and on top of that, read up the FA on the company and take a calculated risk on it esp if the compy has sufficient MoS on it.

bgting :

You may like to read up on Professor Damodaran.

theintelligentinvestor :

I am not a believer in beta. I have a simple and I think a logical approach to discount rate from my post. It has served me well, I don't think we need to be accurate in being right.


I prefer to use fcf or sometimes net earning or even comprehensive earning depending on the company. Just my preference to focus on real earnings rather than dividend payout. If FCF may not work for erratic cash flow trend, I might look at net earning. There is business where part of the earnings can be from the investment cash flow and also unrealized gain from investments are not shown in P&L, eg insurance, then I will use comprehensive income. Important to me is what are the real potential earnings to a business, and if the retained earnings will translate directly to increase in the shareholder equity.

To invest money in a business, I need to be fairly confident that there will be 2 real birds in the bush over time, as Buffett would say.

theintelligentinvestor :

Reply to @weishengchua : In a way, I am saying if I am right in my assessment of a company potential, will a discount rate of 11 or 12% makes a huge difference?

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ContrarianValuer :

I am personally not a fan of CAPM, due to the fact that it associates risk with volatility. As the cliche adage goes, short term voting machine, long term weighing machine. Volatility means nothing but opportunity!

And also because CAPM accounts for overall market risk less RF, to derive RP, which I think is unreliable as RP should account for the riskiness of the individual security and not benchmarked to overall market performance.

I derive my discount rate via a simple approach appended in this book, "The Five Rules for Successful Stock Investing" by Pat Dorsey, and use a range of values between 8-15%, gauged qualitatively based on my own risk appetite as well as my own risk perception of the co.

Perhaps, academia taught models like bond yield, or dcf approach will be more feasible than the widely-used and overhyped CAPM, my 2 cents.

ContrarianValuer :

Reply to @weishengchua : I think it is basic to intermediate to me, one of my first books I read when I started out. I suppose you are beyond that now, considering your exposure to academia taught valuations. Good to skim through and filter out applicable points though, one being the DR aspect

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