Show pageOld revisionsBacklinksBack to top This page is read only. You can view the source, but not change it. Ask your administrator if you think this is wrong. ======Company Valuation====== Company Valuation is the process of determining the economic worth of a business. Think of it as putting a price tag not on a company's stock, but on the entire underlying enterprise. For a [[value investor]], this is the most critical skill to master. The stock market constantly throws prices at you, which can fluctuate wildly based on news, fear, or greed. But a company's true, underlying worth—its [[intrinsic value]]—is far more stable. The legendary investor [[Warren Buffett]], a student of [[Benjamin Graham]], famously said, "Price is what you pay; value is what you get." Company valuation is the disciplined craft of figuring out what you are //actually getting//. It’s the essential homework you do to avoid overpaying and to spot wonderful businesses trading at a discount. A solid valuation gives you the confidence to buy when others are fearful and to hold on for the long term, knowing the true worth of what you own. ===== Why Bother with Valuation? ===== In a nutshell, you perform a valuation to protect yourself. Without a firm idea of a company's worth, investing is just speculation—you're essentially gambling on price movements. A thoughtful valuation is the foundation for establishing a [[Margin of Safety]]. Imagine you’ve determined a company is worth about €100 per share. Would you buy it at €98? Probably not. There's little room for error. What if your calculations were slightly too optimistic? What if the company hits an unexpected rough patch? But what if the market, in a moment of panic, offers you that same share for €60? Now you have a €40 per share "margin of safety." This cushion protects your investment from bad luck, unforeseen events, or simple mistakes in your own analysis. Valuation tells you what a fair price is; the margin of safety tells you what a //great// price is. ===== The Two Main Roads to Valuation ===== While there are dozens of specific models, they generally fall into two broad categories. Smart investors often use both to cross-check their work and build a more complete picture. ==== Intrinsic Value (What It's Worth) ==== This approach attempts to calculate a company's value based purely on its own ability to generate cash. The most respected method here is the [[Discounted Cash Flow (DCF)]] analysis. While it sounds intimidating, the concept is simple: a business is worth the sum of all the cash it can produce for its owners from now until Judgment Day, with a small adjustment. Because cash in your hand today is worth more than cash you //might// get a year from now, future cash flows are "discounted" to find their present-day value. A DCF analysis involves estimating three key things: * **Future Cash Flows:** You'll need to project the company's [[Free Cash Flow (FCF)]]—the real cash left over after running the business—over a period, typically 5 to 10 years. This requires a deep understanding of the business and its industry. * **Discount Rate:** This is the rate you use to translate future cash into today's money. A higher [[discount rate]] is used for riskier companies, resulting in a lower valuation, and vice versa. It represents the return you demand for taking the risk. * **Terminal Value:** Since a company doesn't just stop existing after 10 years, you must estimate the value of all its cash flows beyond your projection period. This is the [[terminal value]]. Doing a DCF is more art than science, as it relies on educated guesses about the future. However, the exercise forces you to think critically about the long-term fundamentals of a business. ==== Relative Valuation (What Others are Paying) ==== This is the "shortcut" method. Instead of calculating value from scratch, you compare the company to similar businesses or to its own historical trading patterns. It’s like estimating a house’s value by looking at what similar houses on the same street recently sold for. This is done using [[valuation multiples]]. Some of the most common multiples include: * **Price-to-Earnings (P/E) Ratio:** Compares the company's stock price to its earnings per share. A low [[Price-to-Earnings (P/E) Ratio]] can indicate a bargain. * **Price-to-Book (P/B) Ratio:** Compares the stock price to the company's net asset value (or [[book value]]). A [[Price-to-Book (P/B) Ratio]] below 1.0 means you could theoretically buy the company for less than the value of its assets. * **EV/EBITDA:** Compares the total company value ([[enterprise value]]) to its earnings before interest, taxes, depreciation, and amortization. [[EV/EBITDA]] is often preferred for comparing companies with different debt levels and tax rates. The big risk with [[relative valuation]]? If the entire "neighborhood" (i.e., the market or industry) is in a bubble, your comparison might just tell you that a company is //less overvalued// than its peers, not that it's actually cheap. ===== A Value Investor's Toolbox ===== Ultimately, a company's valuation is not a single, precise number. It's a range of reasonable possibilities. **Your goal is not to be perfectly right, but to be approximately right.** A practical approach is to start with a DCF analysis to build your own view of the company's intrinsic worth. Then, use relative valuation multiples as a sanity check to see how your estimate stacks up against the market's current mood. If your intrinsic valuation suggests a company is cheap, and its relative multiples are also lower than its peers and its own history, you might just be onto a great investment. The valuation gives you the target; your margin of safety tells you when to pull the trigger.