HOW TO MAKE VALUATIONS

SUM-OF-PARTS 

• challenging but an old school approach. this does not work in the traditional manner of calculating asset values. there's more to it these days. in the next section, i'll talk about the changes with intangible assets.

• but right now here's what you need to know, companies are broken up value. very few public companies have single-play stocks. in fact, most companies have multiple divisions and revenue streams. when you begin breaking down the revenue streams, you will understand where money is really flowing.

  • Sum of Parts Valuation is a method of stock valuation that involves breaking down a company into its individual business segments or divisions, and valuing each segment or division separately. The value of each segment or division is estimated based on various financial metrics such as revenue, earnings, and cash flow, as well as industry-specific benchmarks. Then, the values of each segment or division are added up to arrive at a total estimated value for the company. This method is particularly useful for conglomerate companies that operate in multiple industries, as it allows investors to better understand the value drivers for each business unit and to make more informed investment decisions.

• how to value assets and liabilities

  • In a sum of parts valuation, assets and liabilities are valued separately to arrive at an estimate of the overall value of a company. The valuation process involves estimating the value of each segment or unit of the company and then summing these estimates to arrive at the overall value. For assets, this may involve evaluating the market value of tangible assets such as property and equipment, as well as intangible assets such as intellectual property and goodwill. For liabilities, this may involve estimating the present value of future debt payments, as well as the value of any obligations such as pensions or lease obligations. By evaluating each component separately, the sum of parts approach provides a more nuanced view of a company's value and can help to identify areas where the company may be undervalued or overvalued.

DISCOUNTED CASH FLOWS

• there are several valuation methods but this is the most common.

• explain why Buffett uses the 10% hurdle rate.

  • The best hurdle rate for a Discounted Cash Flow (DCF) model depends on several factors, including the riskiness of the investment, the investor's risk tolerance, and the opportunity cost of alternative investments. The hurdle rate is the minimum rate of return that an investment must generate to be considered a good investment. A higher hurdle rate is used for investments with higher risk, while a lower rate is used for investments with lower risk. The best hurdle rate for a DCF model is the rate that accurately reflects the risk of the investment and provides a suitable return to the investor.

  • how to calculate the risk-free rate

    • The risk-free rate is the minimum rate of return that an investor expects for an investment with no risk. To calculate the risk-free rate, one typically uses the yield on a government bond such as the U.S. Treasury bond. The yield on these bonds is widely considered to be a proxy for the risk-free rate, as the likelihood of default by the U.S. government is considered to be very low. To determine the current risk-free rate, one could look up the yield on a current U.S. Treasury bond of a specific maturity, such as the 10-year Treasury bond. It is important to note that the risk-free rate is not constant and may change over time, and that the yield on government bonds may not always perfectly reflect the risk-free rate, as other factors such as inflation expectations may also influence the yields on government bonds.

WHY USE DCFS

• A Discounted Cash Flow (DCF) model is a financial tool used to evaluate the fair value of an investment based on its expected future cash flows and discount rate. To build a DCF model, you need to follow these steps:

  • Identify the expected future cash flows: Project the expected future cash flows of the investment for a specific time period, usually 5-10 years.

  • Determine the discount rate: The discount rate is the cost of capital or the rate of return that investors require from an investment. You can use the Weighted Average Cost of Capital (WACC) as a discount rate.

  • Discount the expected future cash flows: Calculate the present value of the expected future cash flows using the discount rate.

  • Calculate the Terminal Value: The terminal value represents the estimated value of the investment after the projection period. There are different methods to estimate the terminal value, such as the Gordon Growth Model or the Perpetuity Growth Model.

  • Sum the present value of expected future cash flows and the terminal value: The sum represents the estimated fair value of the investment.

  • Compare the estimated fair value to the market price: If the estimated fair value is higher than the market price, the investment may be undervalued and present a good opportunity to invest.

• It's important to keep in mind that DCF models are based on assumptions and projections, and the results are only as accurate as the assumptions and projections used.

What is the difference between DDM and DCF

• DDM (Dividend Discount Model) and DCF (Discounted Cash Flow) are two commonly used methods for valuing stocks.

• DDM assumes that a stock's price is the present value of all its future dividends, discounted at a rate that reflects the risk of the company not paying out these dividends.

• DCF, on the other hand, values a stock based on the present value of its expected future cash flows, also discounted at a rate that reflects the risk of the company not generating these cash flows.

• In essence, DDM focuses on a company's ability to pay dividends, while DCF focuses on a company's ability to generate cash flows. While both methods have their strengths and weaknesses, DCF is generally considered a more comprehensive and flexible approach to stock valuation.

COMPARABLES 

• viewing competitors, how to use stock metrics

  • Comparable company analysis (also known as "peer multiples analysis") is a method used to value a company by comparing its financial metrics to those of its peers or similar companies in the same industry. Here are the steps to use comparable company analysis to value a stock:

    • Select peer group: Choose a group of companies that are similar to the company being analyzed in terms of size, industry, and business model.

    • Gather financial data: Obtain the financial data of the selected peer group companies, including revenue, earnings, and other important metrics.

    • Calculate stock metrics: Calculate key stock metrics such as price-to-earnings (P/E) ratio, price-to-sales (P/S) ratio, and enterprise value-to-EBITDA (EV/EBITDA) ratio for each company in the peer group.

    • Determine the average: Determine the average value for each stock metric for the peer group.

    • Compare to target company: Compare the stock metrics of the target company to the average values for the peer group.

    • Adjust for differences: Adjust the values for the target company to account for any meaningful differences between it and the peer group, such as growth prospects or risk profile.

    • Determine the estimated value: Based on the stock metrics and adjustments made, determine an estimated value for the target company.

  • By comparing the financial metrics of similar companies, comparable company analysis can provide a quick estimate of the fair value of a stock. However, it should not be used as the sole method for valuation and should be supplemented with other valuation techniques for a more comprehensive analysis.

• competitor ratios

  • Price-to-Earnings (P/E) Ratio: This ratio measures the value of a stock in relation to its earnings. It is calculated as the market price per share divided by the earnings per share (EPS). A high P/E ratio can indicate that a stock is overvalued, while a low P/E ratio may suggest that the stock is undervalued.

    • Price-to-Earnings (P/E) ratio: Let's say a company has a stock price of $100 and its earnings per share (EPS) is $5. The P/E ratio would be 20 ($100/$5). This means that for every dollar of earnings, investors are willing to pay $20. A lower P/E ratio may indicate that a stock is undervalued, while a higher P/E ratio may indicate that a stock is overvalued.

  • Price-to-Sales (P/S) Ratio: This ratio measures the value of a stock in relation to its sales. It is calculated as the market price per share divided by the revenue per share. A high P/S ratio may indicate that a stock is overvalued, while a low P/S ratio may suggest that the stock is undervalued.

    • Price-to-Sales (P/S) ratio: Let's say a company has a stock price of $100 and its revenue per share (RPS) is $10. The P/S ratio would be 10 ($100/$10). This ratio measures how much investors are willing to pay for each dollar of revenue generated by the company. A lower P/S ratio may indicate that a stock is undervalued, while a higher P/S ratio may indicate that a stock is overvalued.

  • Enterprise Value-to-Earnings Before Interest, Taxes, Depreciation, and Amortization (EV/EBITDA) Ratio: This ratio measures the value of a company in relation to its earnings before interest, taxes, depreciation, and amortization. It is calculated as the enterprise value (market capitalization plus debt, minority interest, and preferred shares, less total cash and cash equivalents) divided by EBITDA. A lower EV/EBITDA ratio may indicate that a company is undervalued, while a higher EV/EBITDA ratio may suggest that the company is overvalued.

    • Enterprise Value-to-EBITDA (EV/EBITDA) ratio: Let's say a company has an enterprise value of $1,000 and its EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) is $100. The EV/EBITDA ratio would be 10 ($1,000/$100). This ratio measures how much investors are willing to pay for each dollar of EBITDA generated by the company. A lower EV/EBITDA ratio may indicate that a company is undervalued, while a higher EV/EBITDA ratio may indicate that a company is overvalued.

  • It's important to note that these ratios should not be used in isolation and should be considered along with other financial and non-financial factors to make informed investment decisions.

HOW TO VALUE YOUR IDEAS

look this is tricky. the problem is everyone uses different models. there is no one way and there is no right way.

but here's the trap most investors fall into. they use emotions instead of logic. now in some instances that is fine. gut instincts can help when you have deep industry knowledge. but the reality is you probably don't. in fact, you might be making an assumption based on you read or heard.

There are several methods to value a public stock, including:

Price-to-Earnings (P/E) Ratio: compares the stock price to its earnings per share (EPS) to determine the stock's value.

Price-to-Book (P/B) Ratio: compares the stock price to its book value per share to determine the stock's value.

Dividend Discount Model (DDM): estimates the value of a stock based on its future dividend payments, discounted to present value.

Discounted Cash Flow (DCF) Model: calculates the present value of a stock's future cash flows, discounted to present value.

Comparable Company Analysis: compares the stock's metrics (e.g., P/E, P/B, revenue growth) to similar companies in the same industry to determine its value.

It's important to remember that stock valuation is an estimation of a stock's worth and is subject to market changes, economic conditions, and other factors. Therefore, multiple methods should be used to form a well-rounded view of a stock's value.