Author Topic: Monte Carlo Simulation  (Read 1885 times)

nickenumbers

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Monte Carlo Simulation
« on: November 24, 2018, 12:33:34 PM »
Has anyone found value in using Monte Carlo simulation?  Is there a use case for Monte Carlo simulation in our analysis?

Thanks.
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rb

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Re: Monte Carlo Simulation
« Reply #1 on: November 24, 2018, 01:42:07 PM »
Monte Carlo is useful for a lot of things. In my view value investing is not one of them.

Jurgis

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Re: Monte Carlo Simulation
« Reply #2 on: November 24, 2018, 05:15:12 PM »
Damodaran uses Monte Carlo in valuation. I haven't looked into details. Cursory Bing search found this: http://people.stern.nyu.edu/adamodar/pdfiles/ovhds/inv2E/probabilistic.pdf
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LC

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Re: Monte Carlo Simulation
« Reply #3 on: November 25, 2018, 12:46:22 AM »
More useful for VAR estimates and convergence testing.
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SHDL

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Re: Monte Carlo Simulation
« Reply #4 on: November 26, 2018, 01:39:39 PM »
Iíd say it can be useful. 

For instance letís say youíve researched a certain company and youíve decided that the stock will either triple (with prob. 1/2) or go to zero (with prob. 1/2) in a year.  So the expected return is pretty high but so is the risk.  How much of your portfolio do you want to put into it?  Should you instead buy some call options?  If so, which one(s) in terms of expiration date & strike price?  Or would a married put be a better idea?  Using Monte Carlo you can simulate the outcomes of each strategy pretty easily and rank them in terms of your preferred risk/reward metric.  At least for me personally that is a lot easier than trying to do it all by hand or in my head. 

But like any other tool itís GIGO, so you really do need to know what youíre doing.

bbarberayr

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Re: Monte Carlo Simulation
« Reply #5 on: November 27, 2018, 01:56:23 PM »
I found it useful in helping to plan retirement spending approaches - for example, see https://www.firecalc.com/

Cigarbutt

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Re: Monte Carlo Simulation
« Reply #6 on: November 27, 2018, 02:40:23 PM »
I found it useful in helping to plan retirement spending approaches - for example, see https://www.firecalc.com/
Interesting tool. It's always fun to see the power of compounding.
I would only say (from the 5 minutes spent on your link) that the output seems to be based on a forward application of a range of historical returns (ie as if history repeats itself) and not on a classic Monte Carlo Simulation which is more like what the future may be given a certain set of assumptions thrown into an equation and run an "x" number of times.

clutch

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Re: Monte Carlo Simulation
« Reply #7 on: November 28, 2018, 11:41:59 AM »
You can use MC to compute your intrinsic value +/- variance. For example, instead of using one number for WACC, margin rate, growth rate, etc., you use a range of values (maybe take them from the company's historical record) to model their probability distributions. Then, use MC to sample from those probability distributions to compute a range of intrinsic values.

The variance information can then be used for your portfolio allocation (i.e., bet sizing). Basically applying the idea of Kelly's criterion - place bigger bets (more confidence) on companies with intrinsic values with lower variances.

Interestingly, if you apply this approach, you will basically place bigger bets on non-cyclical and steady "moaty" companies vs. cyclical ones (because cyclical ones will have higher variances in their performance metrics). Also, I find it is a good way to distinguish steady tech companies vs. volatile ones.

clutch

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Re: Monte Carlo Simulation
« Reply #8 on: November 28, 2018, 11:44:56 AM »
Forgot to mention - another way to utilize the variance information is to apply different rates of margin of safety on your intrinsic value calculation. For example, you multiply a discount factor of 0.9 on the intrinsic value for companies with low variance, but 0.7 on those with high variance.

nickenumbers

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Re: Monte Carlo Simulation
« Reply #9 on: November 28, 2018, 12:17:56 PM »
Great discussion everyone.  You have exceeded my expectations.  Everyone gets 6 Golden Unicorns for participating and/or reading  [scratch that, make it 7, you all deserve 7 Golden Unicorns!  I am being generous.]


Seriously now, does anyone have a recommendation for a software or a website to run some Monte Carlo simulations?  Please tell me that I don't have to be a Computer Science major in order to make it work.  I would prefer it to be easy enough for a dumb American from Virginia to operate.

Thanks in advance!
The fastest Cheetah still waits for the lame baby antelope.  ..patience..