Methodologies, Valuation

DCF for Cyclical Companies

I used to think that one can “average out” or “smoothen”/”flatten” the earnings of a cyclical company across one full cycle so as to do the valuation. I realise now that that is actually not correct.

The “smoothening” process can only help you get the earnings figure at a particular point in time in the future (i.e., x cycles ahead). The smoothened out earnings stream cannot be used for valuation as that would not reflect reality. You would still need to do some fancy time series stuff to generate the future earnings stream if you want to do some form of DCF.

Can you still Buffett’s methodology (according to Buffettology) using a single earnings point in the future? Can you still use the average P/E? My thoughts on this in the next post….

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