Stock Valuation

In any kind of valuation there are three basic uncertainties:

Estimation Uncertainty

Even if our information sources are impeccable, we have to convert raw information into inputs and use these inputs in models. Any mistakes or wrong assessment that we make at either stage of this process, will cause an estimation error.

Firm-specific Uncertainty

The path that we envision for a firm can prove to be hopelessly wrong. The firm may do much better or much worse than we expected, and the resulting earnings and cash flows will be very different from our estimates.

Macroeconomic Uncertainty

Even if a firm evolves exactly the way we expected it to, the microeconomic environment can change in unpredictable ways. Interest rates can go up or down, and the economy can do much better or worse than expected. These macroeconomic changes will affect value.

CAGR

Compounded Annual Growth Rate

The compound annual growth rate (CAGR) is a useful measure of growth over multiple time periods. It can be thought of as the growth rate that gets you from the initial investment value to the ending investment value if you assume that the investment has been compounding over the time period.

DCF – Discounted Cash Flow and Intrinsic Value

A valuation method used to estimate the attractiveness of an investment opportunity. Discounted cash flow (DCF) analysis uses future free cash flow projections and discounts them (most often using the weighted average cost of capital) to arrive at a present value, which is used to evaluate the potential for investment. If the value arrived at through DCF analysis is higher than the current cost of the investment, the opportunity may be a good one.

Price to Equity (P/E)

A valuation ratio of a company’s current share price compared to its per-share earnings.

Price to FCFE