Stock Valuation
Boring Companies
1-year excess return period: companies in highly competitive, low margin industries.
FCF Model Steps
1. Forecast company's expected cash flows. FCFF = Revenues - Operating Expenses - Net Investment - Taxes 2. Estimate the company's weighted average cost of capital. 3. Calculate the enterprise value of the company. Enterprise Value = cash flow from operations + residual value + short-term assets 4. Calculate Intrinsic Stock Value Intrinsic Value = enterprise value - long term debt - short term liabilities - preferred stock
Great Companies
10-year excess return period: companies with great growth potential, brand names, and marketing power.
Decent Companies
5-year excess return period: companies with decent reputations but that don't control pricing or growth in their industry.
Good Companies
7-year excess return period: companies with good brand names and large economies of scale.
Stock Return
= (Dividends + Change in Stock Price) / Beginning Stock Price
Free Cash Flow to the Firm Model
A four step process to determine the value of the company's stock.
Perpetuity
A set payment amount that continues infinitely on regular intervals. Value of a Perpetuity = Annual Cash Flow / Discount Rate
Discounted Cash Flow Analysis
A stock's value is determined by finding the sum of the company's expected future cash flows discounted back to today's dollars at an appropriate interest rate.
Relative Valuation
Analysts compare a company's measure of value, including P/E ratio, price to book ratio, price to sales ratio, price to earnings to growth, to similar companies within the industry.
Target Stock Price Analysis
Analysts forecast a firm's earnings per share and then multiply EPS by the firm's P/E ratio to determine the firm's target stock price.
Modern Portfolio Theory
Based on belief that stock prices always reflect intrinsic value and that any type of fundamental or technical analysis is already embedded in the stocks price.
Common Stock Claims & Liability
Common stockholders have a residual claim on the firm's assets. Common stockholders have limited liability.
Stocks & Interest Rates
Higher interest rates decrease market value and lower yields and lower interest rates increase stock value, its a inverse relationship.
Profit & Stock Value
Higher profits increase a stock's value and lower profits decrease its value, in a direct relationship.
Free Cash Flow to Equity Model
Measures the company's cash flows after accounting for payments for working capital, capital expenditures, the interest and principal on debt, and dividends on preferred stock; then discounts those cash flows at the company's cost of equity to arrive at the stocks value.
Value of Perpetual Cash Flows
Net Operating Profit after-tax / WACC
Residual Value
Once the company loses its competitive advantage, the company's after-tax earnings can be treated and valued as a perpetuity.
Excess Return Period
Period where the returns a company earns on a new investment is greater than the company's WACC
Common Stock
Represents ownership in a publicly held company.
Fundamental Analysis
Stock analysis based on determining a stock's intrinsic value and the assumption that a company's stock price will move to its intrinsic value over time.
Technical Analysis
Stock analysis based on the belief that prices are influenced more by investor psychology and the emotions of investors than by changes in the fundamentals of the company.
Stock Value & Dividend Policy
The dividend policy should not affect the current value of a stock. However, the expected future value of a stock is greatly affected by dividend policy.
Discounted Dividend Model
The most basic DCF approach, where the value of a stock is the present value of the dividends that an investor expects to received from the stock if the investor holds the stock forever.
Intrinsic Value
The true value of a company's stock, which is a function of the company's revenue, growth, earnings, dividends, cash flows, profit margins, risk, interest rate, and any other factors that affect the value of a company.