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fix the DCF terminal_value with Gordon Growth Model #213

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fix the DCF terminal_value with Gordon Growth Model #213

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5 changes: 4 additions & 1 deletion src/agents/warren_buffett.py
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Original file line number Diff line number Diff line change
Expand Up @@ -355,6 +355,7 @@ def calculate_intrinsic_value(financial_line_items: list) -> dict[str, any]:
growth_rate = 0.05 # Conservative 5% growth
discount_rate = 0.09 # Typical ~9% discount rate
terminal_multiple = 12
terminal_growth_rate = 0.02 # Terminal growth rate (typically close to the long-term GDP growth rate)
projection_years = 10

# Sum of discounted future owner earnings
Expand All @@ -365,8 +366,9 @@ def calculate_intrinsic_value(financial_line_items: list) -> dict[str, any]:
future_value += present_value

# Terminal value
terminal_value = (owner_earnings * (1 + growth_rate) ** projection_years * terminal_multiple) / ((1 + discount_rate) ** projection_years)
terminal_value = (owner_earnings * (1 + growth_rate) ** projection_years * (1 + terminal_growth_rate) / (discount_rate - terminal_growth_rate)) / ((1 + discount_rate) ** projection_years)
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This should be:

terminal_value = (
    owner_earnings * (1 + growth_rate) ** projection_years
    * terminal_growth_rate / (discount_rate - terminal_growth_rate)
) / ((1 + discount_rate) ** projection_years)

if you want to use the Gordon Growth model!

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Thanks for replying. I did some research which supports my point including https://stablebread.com/warren-buffett-intrinsic-value/ and https://www.investopedia.com/terms/g/gordongrowthmodel.asp.

FV of TV = FCFn × (1 + g) / (r - g)
FV of TV = future value of terminal value
FCFn = Free cash flow for the last 12 months of the forecast growth period
r = discount rate (required rate of return)
g = estimated annual terminal growth rate


# Calculate intrinsic value
intrinsic_value = future_value + terminal_value

return {
Expand All @@ -376,6 +378,7 @@ def calculate_intrinsic_value(financial_line_items: list) -> dict[str, any]:
"growth_rate": growth_rate,
"discount_rate": discount_rate,
"terminal_multiple": terminal_multiple,
"terminal_growth_rate": terminal_growth_rate,
"projection_years": projection_years,
},
"details": ["Intrinsic value calculated using DCF model with owner earnings"],
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