Recently, a SeekingAlpha writer published a bullish article on FactSet (NYSE:FDS). While I respect the author's honest effort, I believe there are several issues with the article's central arguments that should be addressed for the benefit for the *amateur investment community*. My goal with this article is not to specifically address the above mentioned article (which, by the way, you do not need to read), but to offer what I believe are the key factors that *the market* cares about as it relates to FDS and how investors should think about the company's valuation.

In my opinion, one of the most common errors made by amateur investors is the lack of respect for how efficient U.S. equity markets actually are. For companies with a market capitalization of $1 billion+, fundamental data and key ratios are widely available and understood by the *professional investment community.* Thus, valuation models that use widely understood and expected numbers as inputs should yield an estimated value that is roughly in line with the company's actual valuation. If the two numbers are grossly different, then one should exam whether one's input assumptions are materially different (and if it is, justify it) or whether the model being applied is simply inappropriate. All too often, amateur investors apply the wrong valuation model.

Let's examine one of the simplest - but effective - valuation models in my arsenal. Let's call this model the *3 Factor Discounted Cash Flow Model*. This model is simple and easy to use, and is most effective for generating a quick understanding of a company's valuation by focusing on three key factors: revenue growth assumption, operating income growth assumption, and historical valuation.

**FDS's TTM Revenue and Operating Income ($MM)**

Without a doubt, FDS has generated some very strong growths. Taking the 3-year moving average, FDS grew revenue by 10% in FY13, which is the fastest growth since 2008. Prior to the financial crisis, the company grew revenues between 12.1% to 23.5%, but in those days the company had a much smaller revenue base to work with. For our model, we assume a revenue growth of 10% per year for the next 5 years.

Also looking at the 3-year moving average, operating margins have been pretty steady over the past decade at around 33%, plus or minus 1%. For the last 3-year average, operating margin stood at 32.7%, which is the number that we will use for our model.

For historical valuation, we will use enterprise value over operating income - this is very close to the classic EV/EBIT multiple, so we will just call it that. Looking at the EV/EBIT for at quarterly intervals since Feb. 1996, the company's median EV/EBIT is 15.6 with a standard deviation of 4. Since current EV/EBIT stands at around 15, we will use this number in our model.

As of 2/28/2014, the company is paying out approximately $60 million in dividends per year. We will not use historical dividend growth rates since the dividend payout ratio has nearly doubled over the past decade to 29.5%. We will assume dividends will grow in line with revenue at 10%.

For the discount rate, we will apply a very generous if not discretionary 10%.

Using our revenue growth assumption of 10% for the next 5 years and applying an operating margin of 32.7%, we arrive at an operating income of $451 million by 2018. Assuming we sell FDS as a multiple of 15 EV/EBIT, we arrive at a market value of $6.77 billion. Over the next 5 years, we will also collect dividends of $403 million. Discounting our annual dividends and final sale price at 10%, we arrive at a NPV of $4.505 billion, which is nearly exactly the current market capitalization of $4.46 billion with a variance of 1%. Note that I did not fudge the numbers to arrive at this estimate - I simply did what I normally do and arrived at the market value.

If you use an inappropriate valuation model, you may get a wildly different value from market value. For example - and not to pick on the author - the valuation model the above mentioned author used to value FDS is an completely inappropriate perpetual discount model that essentially assumes that *free cash flow* will be distributed out every year and, even after distributing all free cash flow, the company is still able to generate its historical growth of 12%. This, of course, is wildly different from the actual distributed cash of approximately $60 million.

Amateur investors may use my 3 Factor DCF model presented above as a starting point. If the result is grossly different from the current market value, then one should dig deep to understand the key factors the market is using to value the stock. In addition, one should further understand the company to make adjustments to the simple 3 Factor DCF model. Normally, without evidence to the contrary, a company's revenue and margin growth should not dramatically change from the status quo over the next 5 years. One should also be realistic around cash-to-cash returns (how much you pay, how much you actually receive in return) instead of relying on highly theoretical numbers such as FCF.

In the comment section below, let me you know if you believe FDS' revenue or margins will change materially in the future and why you believe so. Thank you for reading!

**Disclosure: **I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.