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Comment by hmahncke | Hacker News Reader

I worked at a McKinsey once upon a time, and this is exactly how we did valuations. But this article elides the fact that with this kind of model, you can quite literally get any output you want from choosing your assumptions. In my view, it was better used as a "what assumptions would you have to believe to believe in a given valuation" rather than a valuation approach per se. It can be helpful to know that you'd have to have untenable assumptions to justify a given valuation. In any case, I bet the DCF model generates lower values than the private markets are paying, so it's only interesting to such companies in the public markets where you can act on your beliefs by going short.

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Thanks for the comment. Though I am wondering, as a consulting firm not a finance firm, why does McKinsey model and value companies? Are they brought into double check?

It's a strategy consulting firm and often strategy involves valuation; like should we buy a competitor or divest a division. Generally if the strategy went all the way through to an action, an investment bank would get involved to finalize things.

I worked in a different consulting company.

We're brought in to double check, but also do conduct due diligence and valuation. There's some overlap between financial services and consulting companies. In some deals, you might have a bank on one side and a bank + consultants on the other.

Also, banks are good at doing standard, off-the-shelf valuations. They usually know little about the specific industry and use one-size-fits-all models.

If you want a detailed valuation, taking in account scenarios, industry changes, etc. you need people who know the industry pretty well, which usually means hiring consultants (who either are industry experts, or hire external industry experts).

In some cases, private equity firms also fill in the role of the bank in valuations. I've worked on a multi-party investment deal where one company had consultants (us), another had a bank, and another had a PE firm helping them. Looking at the different approaches and models from each company was a very interesting experience.

Exactly. I was a partner at McK and, at the time, valuation engagements were an important line-of-business, both for private equity firms or in tandem with bankers (M&A, IPOs...).

Would you trust a real estate agent who is paid only if the commission occurs? Both the buyers and sellers bankers only get paid on a transaction. Paying for the time can give an independent valuation. Also, many times valuations don't impact transactions.

That is kind of how it works when selling a house with a real estate agent.. they only get paid on a sale, and they went to sell as cheap as possible so they get their money.. see https://www.youtube.com/watch?v=17jO_w6f8Ck

That's my point - you don't trust them. And shouldn't trust investment banks who get paid on transactions for coming up with a correct price. (Hence you call McKinsey for the 2nd opinion since they get paid on time rather than transaction.)

> That's my point - you don't trust them.

Actually most people DO trust them. I would eat my hat if 90% of people don't agree to sell their house at what the listing agent suggests.

Fair enough. Maybe I'm just the cynic. The real estate agent trying to sell my Mom's house came up with a dozen reasons on why it should sell for mid-300s. I did the analysis on the same data and came up with mid-400s. We'll see where it lands.

Ya. Usually what it comes down to is you need to wait. I bet your agents price would sell within a month.

I asked for a higher price on my house, and it took about 90 days to turn it over... was worth the wait though, say 15k more in my pocket.

> ... it's only interesting to such companies in the public markets where you can act on your beliefs by going short.

I disagree. As Keynes stated, the market can stay irrational longer than you can stay solvent.

I'm curious - how did you determine defensible discount rates at McKinsey?

Former Bain consultant. We used comps from public companies to sense-check things.

The interest rate for an energy conglomerate would not be something you would also use for a non-diversified tech company like Dropbox. As long as we could sell the number (both internally and to the client).

But within like OP said, the range of defensible numbers is still quite wide.

Did you ever use WACC, or is that not realistic?

We did use WACC, which invariably led to arguments about how to correctly calculate WACC as well. For a division of a large company, it can be non-trivial to decide what the appropriate WACC is.

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