The Art of Intrinsic Valuation

Chapter 1 makes a case for "Why you should value a business or a company". Exploring the fundamentals of analyzing the gap in Price and Value of a Stock, and expectations built in the current stock price, I examine what factors need to change to drive the value of a company up and identify opportunities available to the business for the creation of wealth.

• The Gap in Price and Value
• Analyzing Expectations
• Identify Opportunities that are available to Create Wealth
• Going Public, Successions or Family Realignment
• Capital Raising

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Chapter 2 introduces the readers to Intrinsic Valuation / Business Valuation. Specifically, explaining what Intrinsic Valuation is with a simple demonstration of computing intrinsic valuation.

• Who are Investors ?
• What is Intrinsic Value ?
• Table 1 : A simple example of computing Intrinsic Valuation

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Chapter 3 briefly gives a bird's eye view of the "Valuation Process Chart". Depicting the essential begins with a story on how to build up Cash Flows.

• Figure 1 : Valuation Process Chart
• Table 2 : Explaining the Chart in Numbers

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Chapter 4 explains the concept of the Time Value of Money and Discount Factor. "How many millionaires do you know who have become wealthy by investing in savings accounts ? I rest my case." - Robert G. Allen. Do have a look at Table 3 to develop a clear framework on the Time Value of Money and Valuation.

• Present Value of Cash Flows
• Table 3 : Tabular illustration of Time Value - Cash Flows

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Chapter 5 accords how Narrative and Stories are the starting points of each valuation. The launch of a new product, tapping into new market segments, developments in the industry, change in the board members etc., are changes that may come to you in the form of news/announcements but hold numerical value to turn around the Valuation of the Company. I attempt to convert stories into numbers to understand Valuation better.

• Narratives, Numbers and Valuation

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Chapter 6 provides a view on Longevity - the secret to sustaining Company Valuation. It explains why the Forecast Period is an important value driver and what factors define longevity for a company. To know whether a company will survive the test of time or fizzle out after a few interesting moves, longevity helps you uncover the tale! Incorporated in the chapter are stories of some real-world companies such as Apple, Pfizer, and Coca-Cola, etc. and demonstration of how longevity is their secret to creating Value.

• Longevity: An explanation
• Factors defining Longevity of a Company

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Chapter 7 briefly explains Inflation and its fundamental importance in computing Risk-Free Rate, Cost of Debt, Cost of Equity, and Sales Growth.

• Expected Inflation
• Price-Led Growth

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Chapter 8 illustrates the computation of Sales Growth Rate. It is one of the most important steps in forecasting cash flows and a key value driver in valuation. From market size, market opportunity and industry growth rate to the company's competitiveness, investments, pricing power, product mix and product strategy - I take you through various factors that determine Sales Growth Rate.

• Explanation on Sales Growth and factors driving its growth
• Table 4 : Illustrative explanation on computation of sales

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Chapter 9 explains the Operating Profit Margin computation and the importance of the business model on the Operating Profit Margin. How much money is the company making and how is it making money are key questions that need to be answered before weighing a company's value. This chapter explains the paramount importance of Target Operating Profit Margin in driving the value of a company.

• Target Operating Profit Margin
• Table 5 : Illustrative explanation on computation of Operating Profit

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Chapter 10 is all about Fixed Asset Investment Rate. Some companies need lots of capital to grow while others grow by being asset light and creating wealth.

• Incremental Fixed Assets

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Chapter 11 is all about Net Working Capital Investment Rate. Some companies need lots of capital to grow while others grow by being asset light and creating wealth.

• Introduction to Incremental Net Working Capital Investments
• Table 6 : Illustrative explanation of computation of Investment Rate

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Chapter 12 provides an explanation of Income Tax Rate and computation of Net Cash Flows. The company's policies of revenue recognition, statutory income tax rates etc., significantly influence the Income Tax a company pays for a year. The Income Tax Rate has a significant impact on valuation.

• Income Tax during the Forecast Period
• Income Tax Rate during Terminal Period
• Table 7 : Illustrative explanation of computing Net Cash Flow

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Chapter 13 is all about Capital Structure and Debt Equity Ratio. One has to make sure that the company has the right Capital Structure to be successful in Creating Value. Cost of Capital is not only governed by business risks but financial risks too.

• Capital Structure should depend on the Lifecycle of the company and the type of Industry
• Cost Implications
• Debt Equity Ratio
• Table 8 : Illustrative explanation of computing Debt Equity Ratio
• Market Capitalization or Estimated Valuation

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Chapter 14 explains the components built in the Cost of Debt in Nominal Terms.

• Real Interest Rate
• What is a Risk-Free Rate ?
• Default Spread
• What is Expected Inflation ?
• Interest is tax deductible
• Table 9 : Illustrative example of computing After-Tax Cost of Debt

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Chapter 15 takes you through the Computation of Cost of Equity based on the Capital Asset Pricing Model. One of the key determinants of value is the returns one expects from the stock. This chapter juggles with formulae and practical computation of Cost of Equity based on expected returns and risks.

• An explanation of Capital Asset Pricing Model
• Table 10 : Illustrative example of computing Cost of Equity

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Chapter 16 exemplifies the computation of WACC or Cost of Capital and the discounting of the Cash Flows by WACC. Through a hypothetical example and calculations, I compute WACC and discount back the Forecasted Cash Flows to Present Value.

• Tabular explanation of Weighted Average Cost of Capital
• Table 11 : Illustrative example of computation of WACC
• Discounting Cash Flows
• Table 12 : Illustrative example of Discounting Cash Flows

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Chapter 17 is about Expected Market Return (EMR), used in the computation of Cost of Equity. The EMR is the most important variable in computing Cost of Capital. The chapter provides a simple way to compute EMR based on expected returns over inflation.

• Formula for calculating Cost of Capital
• Model for computing Expected Market Return (R_m)
• Inflation and Duration

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Chapter 18 explains the computation of Terminal Value. Terminal Value forms a large part in the Valuation of any business or Company.

• Explanation of Terminal Value
• Computing Terminal Value
• Illustrative example of computation of Terminal Value
• Computation of Terminal Value

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Chapter 19 is about Non-Operating Assets and Liabilities. We need to count our assets and liabilities to arrive at the correct value.

• Operating Cash Flows
• Non-Operating Assets and Liabilities
• Cash & Securities
• Investments
• Other Assets
• Minority Interest
• Other Liabilities
• Debt & Obligations
• Outstanding Shares
• Table 13 : Illustrative example of Non-Operating Assets and Liabilities for Black Bay Pizza
• Table 14 : Computation of Shareholder Value

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Chapter 20 introduces Future Value per share. While the current price and value is a determinant of present decision, the Future Value Per Share helps you evaluate how long you should hold a stock and helps you to arrive at the Target Price of a Share.

• Future Value Per share
• Table 15 : Illustrative example of computing Future Value Per Share

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Chapter 21 summarizes and revisits all the computation of Valuation we just learned in the previous chapter through a hypothetical case of Snap Value.

• Illustration of Computing varied components of Intrinsic Valuation of a Business with a hypothetical example
• Table 16 : Valuation of Snap Value

Read Chapter 21