MDCF valuation models

: multi-factor discounted cash flow valuations

Abstract

DCF valuation models discount cash flows at a rate that reflects the risk of the investment, the opportunity cost of capital. The early works of the 60s by Markowitz (1952), Treynor (1961, 1962), Sharpe (1964), Lintner (1965) and Mossin (1966) renowned the CAPM as the cross-sectional equity return model. In parallel, since the contributions of Fama & French (1992, 1993, 2015) and Carhart (1992, 1995, 1997), there were no significant changes in the risk assessment of such valuation models. By testing the early valuation models of Fisher (1930) and Kaplan & Ruback (1994), with the CAPM, FF3, FFC, and FF5 equity models, throughout the most mature companies (1987 to 2017) of the SP100 index, in a total of 1364 valuations, it was statistically proved that the Multi-factor Discounted Cash Flows (MDCF) valuation models outperform the cross-section of returns of the CAPM for valuation purposes, with a T-test p-value lower than the 5% conventional level. Unfortunately for practitioners, cross-sectional methodologies are not as accurate as the Historical Discounted Cash Flow (HDCF) valuation methodologies, and as such, any given model can outperform a cross-sectional model. Furthermore, HDCF valuations allow for the input of errors, providing reference values and fair price corrections.

Date of Award	13 Jul 2023
Original language	English
Awarding Institution	Universidade Católica Portuguesa
Supervisor	João Pinto (Supervisor)