What stock pricing model do Wall Street analysts use to come up with their "fair price"?

Question

Theory says the discounted FCF model is the best way to get the true instrinsic value of a stock. However, in the real world, this model does not come up with number close to the ones you see on the analysts' reports. Any idea why?

Answer 1

Each analyst has his own model and won't tell you what it is because these predictions are how he makes his living. What numbers to put in and how much weight to give each is a matter of opinion and judgment. The analyst is being paid for his judgment, not for plugging numbers into a standard formula.

For example, even if everybody used the same exact formula for discounted free cash flow, the past doesn't matter. You can't invest in the past. The analyst is using his own ESTIMATES of future FCF. The key word is "estimates" because nobody knows for sure what cash the company is going to generate in the future.

Answer 2

Growth!

Google may not have much free cash flow but what about the potential growth?

On the other hand, MicroSoft throws off a ton of cash but where is the growth going to come from?

Answer 3

Depends on what the firm wants to do.

If they want to buy - sell, it's overvalued.

If they want to sell - buy, it's cheap.

Helps when you keep your valuation model "proprietary."