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Key Financial Ratios
Cash Flow Valuation
What is Cash Flow
Valuation (DCF)?
Cash Flow Valuation, commonly known as Discounted Cash Flow (DCF) analysis, is a financial valuation method used to determine the value of an investment based on its expected future cash flows. The principle behind DCF is that the value of an asset is equal to the present value of all future cash flows that the asset is expected to generate. This method is widely used in finance to evaluate investment opportunities, corporate valuations, and to make decisions on mergers and acquisitions.
The basic steps involved in a DCF analysis
How does Cash Flow
Valuation (DCF) Work?
DCF works by projecting the future cash flows that an investment will generate and then discounting them back to the present value using a discount rate. This discount rate typically reflects the expected rate of return from the perspective of the investor.
Forecasting Future Cash Flows
Estimate the future cash flows that the investment will generate over a specific period. Invest Viable have mathematically automated projections that looks at how the company have done the last years and forecast that the company will continue the same performance
Choosing a Discount Rate
This is where you as an investor comes in and decide how much yearly return that you expect from your investment, the higher return that you expect per year, the lower price you need to pay for your stock. Typically you would need a higher expected return if you take greater risk. Consider this, and also the time value of money, being that money is loosing its buying power over time.
Calculating Present Value
Discount the future cash flows to their present value using the chosen discount rate.
Summing the Present Values
Add up the present values of all projected future cash flows to get the total value of the investment.
The DCF Formula
How is Cash Flow Valuation (DCF) Calculated?
The DCF Formula is:
In this formula:
DCF
Discounted Cash Flow is the total present enterprise value of the company based on future cash flows
Cash Flow
The projected cash flows expected in period.
r
The investors expected rate of return represents how much the investor expects in yearly returns on invested amount. It is used to discount future cash flows to their present value.
t
Time period (typically in years).
Investor Decisions
What does Cash Flow
Valuation (DFC)
tell an Investor?
DCF provides investors with a measure of the intrinsic value of an investment. By comparing the DCF value to the current market value, investors can make informed decisions. In summary, DCF is a powerful valuation tool that helps investors assess the value of an investment based on its expected future cash flows, adjusted for the time value of money and risk. It provides a clear framework for making investment decisions and understanding the intrinsic value of assets.
Undervalued Investment
If the DCF value is higher than the current market value, the investment may be undervalued and potentially a good buy.
Overvalued Investment
If the DCF value is lower than the current market value, the investment may be overvalued and potentially a sell or avoid.
Investment Comparisons
DCF allows for the comparison of different investment opportunities based on their intrinsic value, facilitating better decision-making.
Understanding Risks and Returns
By incorporating the discount rate, DCF accounts for the time value of money and the risks associated with future cash flows, providing a comprehensive view of the investment’s potential returns and risks.
EBITDA Valuation
What is EBITDA
Valuation?
EBITDA Valuation is a financial metric used to evaluate the value of a company based on its Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA). This valuation method is particularly useful for comparing companies within the same industry as it focuses on the core operational profitability, excluding the effects of financing and accounting decisions.
The basic steps involved in an EBITDA valuation
How does EBITDA
Valuation (DCF) Work?
EBITDA valuation works by analyzing a company’s EBITDA and applying an appropriate multiple to determine its enterprise value. This multiple is often derived from industry standards, comparable company valuations, or historical data. The principle behind this valuation method is that EBITDA provides a clearer picture of a company’s operational efficiency and profitability, making it easier to compare with peers.
Calculating EBITDA
Calculate the EBITDA of the company by adding back interest, taxes, depreciation, and amortization to the net income. This measure isolates the company’s earnings from operational activities.
Choosing an Appropriate Multiple
Determine the EBITDA multiple to be used, based on industry benchmarks, comparable companies, or historical trading multiples. This multiple reflects how much investors are willing to pay for each unit of EBITDA.
Calculating Enterprise Value
Multiply the company’s EBITDA by the chosen multiple to estimate the enterprise value (EV).
Adjusting for Debt and Cash
Adjust the enterprise value by subtracting net debt (total debt minus cash and cash equivalents) to derive the equity value of the company.
The EBITDA Formula
How is EBITDA Valuation Calculated?
The EBITDA Formula is:
In this formula:
EBITDA
Earnings Before Interest Taxation, Depreciation and Amortization
EBITDA Multiple
A multiple used to valuate a company to compare it with companies in similar industry.
Investor Decisions
What does
EBITDA Valuation
tell an Investor?
EBITDA valuation provides investors with a quick and efficient way to compare the operational performance and value of companies within the same industry. By using EBITDA, investors can make informed decisions based on the company's core profitability, independent of capital structure and non-operational factors.
In summary, EBITDA valuation is a powerful tool for investors to assess a company’s value based on its operational profitability, providing a clear and comparable measure that aids in investment decision-making and understanding the intrinsic value of a company.
Operational Efficiency
EBITDA valuation focuses on the company’s core operational performance, excluding the effects of financing and accounting decisions.
Comparability
It allows for easier comparison of companies within the same industry, as it standardizes earnings by removing non-operational effects.
Valuation Insights
By applying an industry-standard multiple, investors can quickly estimate the enterprise value and equity value of a company.
Debt Adjustments
The adjustment for net debt provides a clearer picture of the company’s equity value, making it easier to assess the potential return on investment.
Graham Fair Value
What is Graham
Fair Value?
Graham Fair Value is a financial valuation method introduced by Benjamin Graham, often referred to as the father of value investing. This method seeks to determine the intrinsic value of a stock by considering both its earnings and growth prospects. Graham’s approach is more conservative than other valuation methods, emphasizing a margin of safety to protect against uncertainties.
The basic steps involved in a Graham Fair Value Analysis
How does Graham
Fair Value Work?
Graham Fair Value Valuation works by calculating an intrinsic value based on a formula that incorporates a company’s earnings per share (EPS) and expected growth rate. This formula provides a benchmark for evaluating whether a stock is overvalued or undervalued.
Calculate Earnings Per Share (EPS)
Obtain the company's EPS, which is a measure of the company's profitability allocated to each outstanding share of common stock.
Estimate the Expected Growth Rate
Determine the expected annual growth rate of the company's earnings. This can be based on historical growth rates, industry standards, or analysts' forecasts.
Apply Graham’s Formula
Use Graham’s formula to calculate the intrinsic value of the stock.
Determine the Margin of Safety
Compare the calculated intrinsic value to the current market price to determine the margin of safety. A significant margin of safety indicates that the stock may be undervalued and potentially a good investment.
The Graham Fair Value Formula
How is Graham Fair Value Calculated?
The Graham Formula is:
In this formula:
EPS
Earnings Per Share
g
Expected yearly growth of Earnings Per Share
Investor Decisions
What does
Graham Fair Value
tell an Investor?
Graham Fair Value Valuation provides investors with a measure of the intrinsic value of a stock based on its earnings and growth prospects. By comparing the intrinsic value to the current market value, investors can make informed decisions.
In summary, Graham Fair Value is a conservative approach to determine the intrinsic value of a stock by focusing on earnings and growth prospects. It emphasizes a margin of safety to protect investors from uncertainties, making it a valuable tool for value investors seeking to make informed investment decisions based on fundamental analysis.
Undervalued Investment
If the intrinsic value is higher than the current market value, the stock may be undervalued and potentially a good buy.
Overvalued Investment
If the intrinsic value is lower than the current market value, the stock may be overvalued and potentially a sell or avoid.
Investment Comparison
This method allows for the comparison of different stocks based on their intrinsic value, facilitating better decision-making.
Understanding Risks and Return
By incorporating earnings and growth expectations, Graham Fair Value provides a comprehensive view of a stock’s potential returns and associated risks.
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