Dcf’s/models – frameworks for abstraction

Quite often hear people bad-mouthing dcf’s, but really this needs separating into its component parts. To me, the theoretical framework is something that no analyst can do without (it IS valuation). The practical application is different, with inputs often manipulated to justify pre-conceived valuations.

I saw the comment below today and think it captures it well. It reminds me of a superb fund manager, extremely well qualified and trained, who once, when talking about the then trend for EVA analysis, said ‘what’s wrong with a P/E‘, meaning that if you know your stuff (what is the income recognition policy, growth, cash conversion, moat/RoI/margin etc.), you should pretty be able to work back from a P/E … .

This puts it better than me:

‘… just like DCFs (which is a tool Buffett is skeptical of in practice, despite agreeing with the general method in principle), Buffett and Munger essentially do the cost of capital calculation in their head. They implicitly use and understand both DCFs and cost of capital calculations even if they don’t explicitly label them …

Thoughts On Cost Of Capital And Buffett’s $1 Test – Part 1; John Huber; Value, long-term horizon, special situations, Saber Capital management https://seekingalpha.com/article/4118943-thoughts-cost-capital-buffetts-1-test-part-1

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The importance of underlying numbers – WorldPay FY15 as an example

(In this post, Worldpay is used as an example simply due to the author’s interest in the payments segment).

The following demonstrates what an analyst might be looking to pull out from a company results’ statement, primarily not interested in reported figures, but in underlying/adjusted figures, which we define as excluding currency movements, acquisitions/disposals, and significant and genuine – e.g. not ongoing staff remuneration in shares – one-offs. (For clarity, our usage of underlying differs from the company’s usage in its results statement: the company does not adjust for currency and acquisitions in its definition, but does so separately).

The below is not in-depth, just a quick pull-out of numbers, the way that an analyst might do when first trawling through figures. We have focused on revenues and EBITDA, and have not looked at the make-up of EBITDA, or whether it is the appropriate metric.

In the below context specifically, notice also the probable benefit in the UK from pricing, which the analyst will be trying to place in the context of sustainability in this sector in particular, given intense competition. Note finally the highlighted concluding sentence, which, we would argue, if indeed it does relate to the whole, would be better placed right at the start. Analysts having to pull out negatives from deeper in statements is counter-productive for companies, in our experience.

Due to the speed of clawing out the numbers, there might easily be errors below (the speed/accuracy problem that always faces analysts when results come out – lesson for companies: put all relevant and important information upfront, and remember that underlying numbers are what analysts are looking for).

As regards earnings adjustments, not really addressed below, analysts will take their own view on whether they agree with specific adjustments made by companies, and managements need to be objective/unemotional/develop a thick skin in this regard.

Also note that hitting forecasts in terms of reported (non-underlying) revenues etc. is somewhat arbitrary for companies with significant overseas revenues, as actual currency mixes and hedges almost inevitably will differ from analysts assumptions).

We have added little commentary – clearly an analyst/fund-manager would go on from here to make forecasts/recommendations/judgement calls against their preceding expectations.

This is merely meant as a very quick demonstration exercise, and by no means talks to the company per se.

[For any company, of course, the way the statement is presented and handled, ditto analyst presentations etc. will also talk not just directly, but indirectly to valuation, indirectly not least of all because it talks to ‘risk’].


Revenue [Reported pro-forma revenue +9%]

Excluding the impact of acquisitions and foreign currency translation, overall revenue growth was 5%

+23% Global eCom

+6% WPUS

-8% WPUK

Net revenue

[Reported pro-forma net revenue increased by 14% year-on-year]

Excluding the impact of acquisitions and foreign currency translation, overall net revenue growth was 10%:

+ 16% increase in Global eCom business

+ 3% increase in WPUS

+ 11% increase in WPUK


[Reported pro-forma EBITDA increased by 8% year-on-year]

Excluding the impact of acquisitions and foreign currency translation, overall EBITDA growth was 8%:

+15% Global eCom

+15% WPUK

-17% WPUS

7% increase in corporate costs

Note the significant difference between the UK overall and net revenue growth. Behind this would appear to lie price increases/not passing on interchange reductions (and possibly passing on interchange increases where applicable?):

‘Net acquiring income grew by 18% reflecting the impact of higher transaction volumes and effective management of pricing on new business and renewals, as well as a net positive impact of lower interchange costs on the acquiring margin which funded the enhancement of our propositions for customers. ‘

Final sentence of statement

‘The Directors believe strongly that we have the right strategy and people in place to deliver sustainable growth in the future but it will take longer than previously anticipated to achieve and we will incur additional costs as a result.’ (Note: as this is the concluding sentence, and paragraph, of the company’s narrative, it is to be assumed that this relates to the overall business, but it comes at the end of the US segment and is not separated out under a different heading).

Mark Hawkes

Sources: Worldpay, RNS. 

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Compiling your company’s results’ announcement? Remember: investment analysts are only human

This article was initially published last year. We re-publish it today (with a few minor amendments) as we have seen a few notable instances over the past few months of companies continuing to bury bad news/put a gloss on things, presumably in the (in our view usually mistaken) belief that this is somehow beneficial. Risk and growth are the core fundamental underpinnings of valuation, and we would argue that burying/putting a gloss on  bad news talks negatively to risk: can we trust what is being said, does the company fully appreciate the predicament it is in … .

We comment in the ‘Who we can help‘ section of our website (under ‘Investor Relations Professionals’) that ‘What works in other segments of PR does not necessarily work in the City. One obvious example is that burying bad news in the depths of a results release will usually make things worse rather than better …’.

As we travel around, this comment receives pretty much universal approval from investment professionals, particularly analysts, yet when we look at company results announcements, even examining a random selection indicates that this sensitivity is nowhere near being fully appreciated by many quoted companies. In fact, more strikingly, even in many ‘nothing has changed’ results’ announcements it is clear that fairly obvious things that an analyst (sell side and buy side) really needs, and is looking for straight away, often are not immediately there at the head of releases.

Of course, that a company has probably been through numerous rehearsals and drafts to get to this position, points to an obvious need for a company to have strong advisers, and for the company to listen to them, but that is a subject for another day (another example that points to this need, and alluded to elsewhere on our website, is how very obviously over-priced acquisitions, usually spotted as such within minutes of being published to the City, ever get to the stage of being announced without somebody actually pointing out the obvious, or, if somebody does, why management chooses to ignore the advice: possibly a lack of understanding of valuation).

The point we are making with specific reference to results announcements seems similarly obvious and very, very simple (but companies ignoring it causes significant frustration for analysts): analysts need companies to put all of the most relevant information at the top of the results release.

Investment analysts are only human

I am sure that the reality of most high profile professions is far more prosaic than many outsiders imagine. Yes, many investment analysts are very bright and hard-working, but they are all (only) human – faced with impossible tasks or pressure, they react in the same way as most people: exasperation, frustration, anger … !

The practicalities of an investment analyst’s job are definitely less glamorous than might be imagined and this one key aspect of the investment analyst’s job, dealing with the announcement of company results, is worth Continue Reading →

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