ValuFocus Investing: A Cash-Loving Contrarian Way to Invest in Stocks

Chapter 24

Security Analysis and Modeling

Security analysts work with valuation measures all the time. So, what's new in this book to help you, as a security analyst, perform your tasks better?

Empirically Test Terminal Valuation Model against History

First and foremost, all valuation methods have a terminal value assumption that often is not explicit. We suggest (actually strongly recommend) that you explicitly define your terminal valuation assumptions and empirically test these terminal valuation assumptions or model against history. We make this recommendation because terminal valuations typically are such a large part of current intrinsic valuations. From our experience, terminal valuations typically range from 75 percent to 95 percent of the current intrinsic valuations with two- to five-year forecasts. Excellent references on several models are provided in Chapter 11, “Suppose You Love Your Current DCF Model.”

These empirical tests can measure the core characteristics of your terminal valuation model across the universe of stocks for a decade or more. We recommend these tests to help assure that your terminal valuations are robust, accurate, and unbiased. Accurate, unbiased models tend to achieve both lower risk in a fat-tailed sense and are more predictive of future price movements. That's quite a combination, we might add.

1. Robustness. For how many companies does your terminal valuation model not calculate a value? Why? What percentage of the entire universe does that ...