FCFE vs FCFF vs DDM
Is there any place I can find when each of those method is preferred and why?
FCFE is preferred when the dividend policy of the cover company is not stable, or when an investor has controlling interest in the firm.
Use FCFF to value total value of the firm which include equity and debt investors.
Use DDM when dividend policy is stable, or when an investor does not have a controlling interest in the covered company.
Hope that helps.
DDM: appropriate when the firm pays dividends, dividends are stable, sustainable or can be forecasted. More appropriate than FCF models if you don’t have control (you cannot control the amount of earnings that will be distributed)
FCF models: more appropriate for a controlling shareholder perspective. And when the firm pays no dividends.
FCFE: fine only if FCF to Equity is positive (and even better if they are stable, i.e. when the firm’s capital structure is stable)
FCFF: can be practical when FCFE is negative or not consistent over time due to a changing capital structure (and also when you have no clue about the future capital structure)
I think this is a good way of putting it all together.
Give me a list of factors and I will populate the table to try to create an exhaustive algorithm.
You can post them like this:
Factor 5: 1,0,0
Factor 6: 0,1,0
Negative cash flow: 0,0,0
lol… nice krokodilizm
DDM for when:
- Div are a good proxy for earnings, and/or
- You are just buying shares, not taking control
FCFE for when you plan to have control and could change the Div policy.
FCFF for when the capital structure is likely to change.
Controlling interest is not applicable to FCFF?