You are here60 Seconds Valuation of any stock, for that matter any business.

60 Seconds Valuation of any stock, for that matter any business.


Srikorada's picture

By Srikorada - Posted on 09 October 2009

Have you ever wondered that you don't have the holy grail of valuation and you wish you did. Well, I can't answer that question. However, if you don't have Yahoo! finance and Google Finance and all you have is an annual report and if that report did not list the current market price of the stock, how would you know how much it is trading for? Better yet, what is it's value. I hope you all agree, what the stock is trading at is in no way related to it's value, and we all know that.
 
Let me make few quick assumptions here. You know how to read financial statements. You know where to look for Equity. You know where to look for Free Cash Flow.
 
Also, we are talking about companies which are well run with no accounting gimmicks, profitable, have +ve cash flow, +ve equity, Earnings growth atleast matching inflation. We are not talking about bottom fishing here.
 
Also, as you observe below, we don't care about P/E crap. It is just Crap. So, all we care about is Owner's earnings according to our Guru, Buffett. And it is nothing but the Free Cash flow in simplistic terms. Believe me, you can write volumes on just this topic.
 
So, now you have the annual report.
 
Step 1: Open the balance sheet, go to total equity and grab the number
Step 2: Open the Cashflow statement, either look at Net change in Cash or calculate your own Free Cash Flow. Free Cash flow = Operating Cash Flow - Cap Ex. Also when you calculate the Free Cash Flow, try to take 10 year average. To do this, either you have to do it yourself or use the free services from the library like Morningstar. I like the Morningstart the best. It has always 10 yrs history right there. So you simply take the sum of all 10 yrs and divide by 10.
Step 3: Here is the interesting step.
There are two aspects. Are you OK with the industry standards of the price / Cash flow multiples? Or do you want to set your own multiple based on your expected rate of return.
i.e. If you take industry standards(S&P 500 multiples) , you will get the price. If you want to calculate the Quick Value of the business with your expected rate of return, this would be Intrinsic Value according to you.
So, the question remains;What is your expected rate of return? If you are as capable as Buffett, you would say 15%. That is what he demands on day 1. If you settle for less, it should be atleast 10%. Let us say we are beating Buffett and we also need 15%. Then your inverse yield multiple is 100/15 = 7(rounded). So, essentially you need to multiply the Free Cash flow with a multiple of 7.
Step 4: Add Step 1 + Step 3 (with multiple of 7) = Value
Step 5: Add Step 1 + Step 3 (with S&P 500 multiple) = Price set by the market
 
To prove my thesis. I actually ran the numbers for Honda Motor Company. HMC.
 
I went to MorningStar, because it is free and I love it.
 
HMC Equity latest: 40 bil
HMC Avg 10 year cash flow : 2267 mil = 2.267 bil
7 multiple on FCF = 15.875 bil
Total Value = 40 + 15.875 = 55.875 bil
 
Now, please go to Google Finance and check the market cap as it is set by Mr.Market today = 55.485 bil. So, it is trading pretty close to our Quick Value. We don't have much margin of safety, it is upto you if you want to buy it.
 
Wow, isn't that close? Well, I don't want to take any credit. We all know this, I just put it simply here.
 
BTW, these are the current S&P 500 index multiples as of today, according to MorningStar.
 

S&P 500 multiples according to MorningStar

 
 

Price/Earnings
19

Price/Book
2.2

Price/Sales
1.1

Price/Cash Flow
6.7

Dividend Yield %
2.2

Happy Investing!
 
If you like this idea, please leave a comment and also check out my other articles. 

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