When I began focusing on value investing I started out using a Discounted Cash Flow method to determine the future value of a security. However, the problem with DCF is that it forces you to predict and if you have a long time horizon (say ten years), only a fractional difference in growth rates or risk free rates can move valuations at light year distances.
Consider, for example, a cash flow stream that you would like to discount over ten years with 10 year treasury bonds (3.72% in this example) as a risk free return. Let's assume that the investment is returning $1 in the first year, with an (gu)estimated growth rate of 4%. With these assumptions, the net present value of the investment is $13.17. Now, suppose that the growth rate is 5%. The net present value changes with this increase of one percent to $52.02, an astronomical difference. After tinkering with this method for some time, I came to the conclusion that this forced predicting was leading me astray from finding value. I needed an alternative aproach.
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