Diluted Shares Outstanding In A DCF

“I’m confused about how shares outstanding work in a DCF.  When calculating the fully diluted shares outstanding using the Treasury Stock Method, we need the current share price.  But shouldn’t we use the “intrinsic share price” obtained from the DCF to calculate diluted shares?

I realize this would create a circular reference because the DCF depends on the diluted shares outstanding, but the diluted shares outstanding depend on the share price in the DCF.

Can you clarify?”

Inquisitor:

You’re talking about 2 separate issues here - what a company actually costs to acquire and what a DCF tells you it’s worth.

When you calculate a company’s fully diluted shares at a given share price, you take the basic shares outstanding and factor in the dilution from options (and warrants/convertibles) at that share price.  Then you multiply that number by the share price to get the company’s fully dluted market cap.

A DCF, or any other valuation technique like public comps or M&A comps, is used to tell you what a company should be worth, not what it would actually cost to acquire it today.

In other words, you would never use the implied per share value from a DCF to determine how much it would cost to buy a company.

If you’re doing a DCF the correct way, you do get a circular reference because the per-share price output depends on the fully diluted share count - but the fully diluted share count depends on the per-share price.

To do this correctly, calculate the fully diluted shares using the Treasury Stock Method and use the per-share price in the DCF as the input for fully diluted shares, then use the fully diluted shares output as input in the DCF.  Make sure iterations are turned on in Excel (Alt T + O + C + Alt M + Alt I) and let it iterate (F9) to calculate the correct number.

Career Switch: IT To Investment Banking

“I am looking for advice on how to proceed with my career, and am hoping you might point me in the right direction.  I am currently working in the IT department of a top 5 investment bank after having graduated from a top 10 university with a Computer Science degree 2 years ago.

The IT role hasn’t met my expectations at all and I have decided I would rather go into an investment banking front-office role.

For someone with my background, can I realistically switch over?  Would recruiters look favorably upon my experience?”

Inquisitor:

Generally it is quite difficult to transition from a back-office role (IT, for example) into a front-office role at an investment bank.  Since the firms are so large you tend to get pigeonholed into one area, and no matter how much interest/aptitude you have for front-office work, your requests to transfer will usually fall on deaf ears.

As I wrote in my article on how to get a finance job with an engineering background, there are typically 2 viable options:

1. Take advantage of your quantitative background and go to a hedge fund.  They like recruiting Computer Science graduates and other quantitative majors, and your experience at a bank gives you an edge here. They understand that if you’re smart and quantitative you can pick up anything finance-related along the way.
2. Go to an MBA program and come into banking as an Associate.  The only issue is that with just the IT role at the bank on your resume, you will probably need more experience to get into business school/get into a bank afterward.

I don’t mean to discourage you, but from what I’ve seen it is just incredibly difficult to “lateral” into banking from a field that isn’t closely related (e.g. consulting).  Going outside banking to the hedge fund world or going back for an MBA are higher-probability ways of getting in, especially in a bear market.

Corporate Finance At A Fortune 500 Company

“I was wondering what you thought of Corporate Finance training programs at Fortune 500 companies, such as GE’s Financial Management Program.  Are these at all useful for breaking into investment banking?  If I have the opportunity to do something similar this summer, should I take it?”

Inquisitor:

Corporate Finance at a large company can be one path you take to get into banking, but I would recommend only doing a summer internship rather than a full 2-year program if you do not want to ultimately work at a Fortune 500 company.

Although you do learn lot and will gain a useful skillset, recruiters do not view these programs in the same way they would view experience at an investment bank, private equity firm or hedge fund.  Those 3 are all seen as more “rigorous” - in other words you work a lot more, (perhaps) learn more finance and you’ll be better-prepared for the non-existent work/life balance of investment banking.

If you don’t have or can’t get an internship in one of those 3, it is definitely better to do Corporate Finance at a Fortune 500 than to do something in a completely unrelated field.

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