Stock Valuation Essay

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F R I FINANCE RESEARCH INSTITUTE Short Review on Valuation F R I About Valuation FINANCE RESEARCH INSTITUTE • Valuation often associated with model and numbers. • There is always a story behind valuation • Three main problems in valuation – Bias – Uncertainty – Complexity F • • • • R I Valuation Methods FINANCE RESEARCH INSTITUTE In practice, most people don’t believe in valuation. They must know something that I don’t. Valuation gives the rational to investing. There are 2 (two) methods in valuation: – Intrinsic valuation – Relative valuation • Basic assumption: market makes mistakes and those mistakes will get corrected. F • • • • R I Intrinsic Valuation FINANCE RESEARCH INSTITUTE Intrinsic Value = f(expected cash flow, growth, risk) Intrinsic valuation is valuation of a business based on its characteristics. Designed for cash flow generating assets. Discounted cash flow valuation is a tool for estimating intrinsic value. F R I Discounted Cash Flow FINANCE RESEARCH INSTITUTE • The value of a risky asset can be estimated by discounting the expected cash flows on the asset over its life at a risk-adjusted discount rate. (1 ) (1 ) ( ) = + + ⋯+ 1 1 (1 + ) (1 + ) (1 + ) where: n = life of the asset E(CFt) = expected cash flow in period t r is a discount rate that reflects the risk of the cash flows Assets Liabilities Existing Investments Generate cash flows today Include fixed assets Include current (working capital) assets Assets in Place Debt Fixed claim on cash flows Little or no role in management Fixed maturity Tax deductible Future Investments Generate future cash flows Growth Assets Equity Residual claim on cash flows Significant role in management Perpetual lives Firm Valuation Equity Valuation Assets Liabilities Cash

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