Three Ways to Value a Company

Dear Reader,

Company valuation is the core of investments in publicly listed stocks.

There are three major ways to value a stock:

1) Discounted Cash Flow analysis.  Company's future profits are turned into dividends and discounted into the present divided by the risk premium and compounded by a growth rate. A risk premium is the extra income one demands for holding a risky security, riskier than the generally accepted as riskless government bonds. The so produced value is compared to the stocks' current market capitalization

2) Comparable analysis. An analyst collects data on Price/Earnings, Price/Sales, Price/Book ratios of companies similar to the one valued, for example from the same industry. Than the ratios of the other comparable companies with the valued company are compared and if the current valued company's ratios are lower, than the currently valued company is undervalued

3) Asset Based approach. The net asset value, roughly assets minus liabilities of the company is calculated and than it is compared to the current market valuation of the company. If the net asset value of the company is lower than the market cap, than the company is undervalued.

It has to be considered that the three different approaches are suitable for different types of companies. Currently, I think most technology companies listed in the USA are overvalued based on all three valuation approaches. Most technology companies do not produce dividends for a long time, so the discounted cash flow method is not directly applicable. Many technology companies do not produce net profit, so the comparables method is also only partially applicable only to Price/Sales and Price/Book ratios. The asset based approach is also partially applicable.

Valuation is more an art than science. Finance, like economics is a social science. The opinion of other people matters a lot like the recent mania in GameStop has shown. Actually, in my opinion, to value companies relatively successfully one has to combine hard mathematics with a deep understanding of people psychology.

Disclaimer: The blogposts and comments on this blog and posts on social networks(Twitter, LinkedIn, Facebook etc.) are not investment recommendation, are provided solely for informational purposes, and do not constitute an offer or solicitation to buy or sell any securities. The opinions expressed on the blog are Petar Posledovich's. Petar Posledovich does not guarantee the accuracy of the information presented on this blog and social networks. The information presented is "as is".

Petar Vladimirov Posledovich is not liable for any investment losses incurred by reading and interpreting blogposts on this blog and posts on social networks.

Conflicts of interest: I may possess some of the securities, currencies or their derivatives mentioned in the blogpost and posts on social networks(Twitter, LinkedIn etc.)!

Respectfully yours,

Petar Posledovich