I’d like to take a moment to discuss the growing multitude of “finance hipsters” and why they annoy the crap out of me. No, I’m not talking about hipsters who happen to work in finance, I’m talking about all these bankers who love to hate on the more ubiquitous methodologies in finance like CAPM (or portfolio theory in general) and DCF models. You all know what I’m talking about, in fact, at some point, you (or someone you know) has probably had this conversation:
I’m going to get the cost of equity using CAPM and then get the intrinsic value from my DCF model.
Oh, you still use CAPM and DCF? Man, that’s so déclassé, you know the assumptions they use, right? You should use [insert any obscure, probably firm specific model], it’s way better.
Replace “the cost of equity using CAPM” and “the intrinsic value from my DCF model” with “Modest Mouse’s new CD” or “non-organic milk” and you have the quintessential hipster conversation.
Are they perfect models? No, far from it, and “Banker #2” is right about the assumptions. But, both were huge leaps forward in analysis and deserve a bit more credit. To really appreciate this, it’s important to understand what came before them:
Dow Theory: The predecessor to modern technical analysis was developed from 255 editorials written by Charles Dow. Imagine developing a financial theory from 255 of Paul Krugman’s editorials, it would consist entirely of methods to purchase assets that reliably vote democrat and numerous footnotes on the awesomeness of inflation. Luckily, Charles Dow was a pretty smart guy so the resulting theory isn’t complete and utter gibberish, but some of the 6 tenets of Dow Theory would strike most of you as pretty ridiculous (e.g. The Market has Three Movements.)
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