At the same time, longer the duration, there would be more room for errors. Some years – This is a bit tricky, while longer the duration, the better it is.If a company is young and belongs to the high growth sector, then probably a little under 20% is justified, but no company deserves an FCF growth rate of over 20% Companies can barely sustain growing their free cash flow beyond 20%. FCF (Free Cash Flow) growth rate – The rate at which you grow the FCF year on year has to be around 20%.Some guidelines for the conservative assumptions are – Having stated the above, the only way to overcome the drawbacks of the DCF Model is by being as conservative as possible while making the assumptions. The DCF model may also make you miss out on unusual opportunities as the model is based on certain rigid parameters. Long term focus – DCF is heavily focused on long term investing, and thus it does not offer anything to investors who have a short term focus.Both the inputs and the assumptions of the DCF model needs to be updated regularly. Constant Updates – Once the model is built, the analyst needs to constantly modify and align the model with new data (quarterly and yearly data) that comes in.At 3.5%, the share price is Rs.368/- but if we change this to 4.0% (an increase of 50 basis points), the share price will change to Rs.394/. For instance, in the ARBL case, we have assumed 3.5% as the terminal growth rate. A small change in the terminal growth rate would lead to a large difference in the final output, i.e. Highly sensitive to the Terminal Growth rate – The DCF model is susceptible to the terminal growth rate.This is a challenge, let alone for a fundamental analyst and the top management of the company. DCF requires us to forecast – To begin with, the DCF model requires us to predict the future cash flow and the business cycles.If the assumptions used are incorrect, the fair value and stock price computation could be skewed. The DCF model is only as good as the assumptions which are fed to it. However, the DCF method has its fair share of drawbacks which you need to be aware of. The DCF method is probably one of the most reliable methods available to evaluate a company’s stock’s intrinsic value. We learned about the intrinsic value calculation using the Discounted Cash Flow (DCF) analysis in the previous chapter. In this concluding chapter, we will discuss a few important topics that could significantly impact how you make your investment decisions.
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