Stocks Valuation Methods
Stocks Valuation Methods
Business Plan – A Valuation Method Using Discounted Cash Flows
I got a call from an entrepreneur the other day that was having trouble determining the value of their company. Specifically, the problem was that this entrepreneur’s company participated in a market space that there’s not a lot of publicly traded companies and, quite honestly, just not a lot of history out there. So, they were having problems finding enough information to perform some of the typical valuation analyses such as price to earnings or price to sales. What I recommend in this case is that you lean more heavily on the discounted-cash-flows method. Ideally, you’d like to have to have as many methods as possible and come back to a value, but sometimes you just can’t, and you have to lean more heavily on the others.
What the discounted-cash-flow method does is it takes the cash flows that your company’s expected to generate over a period and, by the way, this information should be contained in your business plan, discounts them back to the present, and you’re usually looking at five years out, minimum of three, sum them all up, and arrive at a value of your company. This method is mathematically a little more difficult than the price-to-earnings or price-to-sales ratio methods. So, if you’re having some problems or need some help, give us a call at the Capital Match Point. What we ultimately want to do is make sure that our entrepreneurs are as prepared as possible for when the time for negotiation comes.
Entrepreneurs seeking capital from investors frequently find that the financial projections they provide are broken down and analyzed using ratios. Every investor has their own idea of what is important and what ratios best reflect that aspect of performance. Many times the task of keeping up with these and understanding them proves tedious and time consuming for an entrepreneur that has a business to run. I advise entrepreneurs faced with sorting out this type of information to think of ratios in five broad categories.
First of all there is profitability ratios. This category includes ratios such as return on equity, return on assets, earnings per share, return on sales and in short, these ratios express net income in terms of a percentage when divided by a chosen return criteria.
Next there are solvency ratios. These help an investor determine the ability of your company to meet near term financial obligations. The most popular solvency ratio is called the quick ratio which is the sum total of your cash, marketable securities and accounts receivable (from your balance sheet) divided by current liabilities (also from your balance sheet and typically defined as obligations due within 30 days).
Activity ratios give investors a sense as to how fast assets turnover within your company. This also gives important insight into cash flow. For example, receivables turnover (credit sales divided by average accounts receivable) calculates the rate at which receivables are collected. A higher number indicates that you are collecting receivables more quickly and are hence bringing cash into the company more frequently. Likewise inventory turnover (COGS divided by average inventory) give an investor a sense of how efficiently inventory is being managed. A high inventory turnover means that product is being sold much sooner after hitting the warehouse and hence turning into cash more quickly than a product that lags in inventory before being sold.
Capitalization ratios such as financial leverage (Return on Investment Return on Assets) and debt to equity gives investor a sense of importance of debt and equity in your company’s capital structure.
Market ratios are very important to investors as they will ultimately play a part in the value an investor places on your company and the amount of stock they will require in exchange for investment. Two very important market ratios that companies seeking capital should understand are price to earnings and return on investment.
Business Plan-Valuation Method – Price to Earnings Ratio
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