Here is one page snapshot on what drives value of company (and its ownership parts called shares)

Value-1

In this post I am not going to dig into those valuation parameters as I have detailed post on these parameters in past, you can read them here and here

We are going on spend some time today on inputs that drives these valuation parameters to draw some conclusion to refine at the process on how we approach on valuing business

Given we are dealing with 7 input factors this post would be in two parts

Free Cash flows

Value-2

Let’s draw some inferences

  • A company which converts its revenue to cash flows higher in proportion to other companies in similar industry should be valued more
  • A company which has relatively less cash expense (better credit terms, tax advantage, deferred expenses) compared to other companies in similar industry should be valued more
  • A company which has lower capital and maintenance expenses compared to other companies in similar industry should be valued more

Earnings

Value-3

Let’s draw some inferences

  • A company which has underutilised capacity with an opportunity to operate at full capacity has potential to sell at higher value when it operates at full capacity
  • A company which has pricing power will be valued relatively more than companies which don’t have pricing power
  • A company which has lower cost structure compared to peers in industry should be valued more

 

Growth Rates

Value-4

Let’s draw some inferences

  • To ensure we don’t err in valuing in companies, it always better to assume conservative growth assumptions relative to GDP growth rates and Industry growth rates
  • Intuitively companies in countries which are growing fast and in growth stage of industrial cycle would be valued more than others

 

Discount rates/Cost of Capital/Opportunity Cost

Value-5

Applying discount rates is a complex art, it’s a number which is very difficult to arrive as discount rates is function of individual’s opportunity cost, prevailing and future interest rates and current and future AAA bond yield

It is very complex to model a perfect discount rate, So we should rely on scenario analysis with 3-4 rates and then make best guess

  • Lower discount rate would increase value so declining interest rates would result in higher value

We will deal with other input variables in next post

Till then please let me know your views in comments below