Fundamental Analysis: A Brief Introduction To Valuation
  1. Fundamental Analysis: Introduction
  2. Fundamental Analysis: What Is It?
  3. Fundamental Analysis: Qualitative Factors - The Company
  4. Fundamental Analysis: Qualitative Factors - The Industry
  5. Fundamental Analysis: Introduction to Financial Statements
  6. Fundamental Analysis: Other Important Sections Found in Financial Filings
  7. Fundamental Analysis: The Income Statement
  8. Fundamental Analysis: The Balance Sheet
  9. Fundamental Analysis: The Cash Flow Statement
  10. Fundamental Analysis: A Brief Introduction To Valuation
  11. Fundamental Analysis: Conclusion

Fundamental Analysis: A Brief Introduction To Valuation


By Ben McClure

While the concept behind discounted cash flow analysis is simple, its practical application can be a different matter. The premise of the discounted cash flow method is that the current value of a company is simply the present value of its future cash flows that are attributable to shareholders. Its calculation is as follows:


For simplicity's sake, if we know that a company will generate $1 per share in cash flow for shareholders every year into the future; we can calculate what this type of cash flow is worth today. This value is then compared to the current value of the company to determine whether the company is a good investment, based on it being undervalued or overvalued.

There are several different techniques within the discounted cash flow realm of valuation, essentially differing on what type of cash flow is used in the analysis. The dividend discount model focuses on the dividends the company pays to shareholders, while the cash flow model looks at the cash that can be paid to shareholders after all expenses, reinvestments and debt repayments have been made. But conceptually they are the same, as it is the present value of these streams that are taken into consideration.

As we mentioned before, the difficulty lies in the implementation of the model as there are a considerable amount of estimates and assumptions that go into the model. As you can imagine, forecasting the revenue and expenses for a firm five or 10 years into the future can be considerably difficult. Nevertheless, DCF is a valuable tool used by both analysts and everyday investors to estimate a company's value.

For more information and in-depth instructions, see the Discounted Cash Flow Analysis tutorial.

Ratio Valuation
Financial ratios are mathematical calculations using figures mainly from the financial statements, and they are used to gain an idea of a company's valuation and financial performance. Some of the most well-known valuation ratios are price-to-earnings and price-to-book. Each valuation ratio uses different measures in its calculations. For example, price-to-book compares the price per share to the company's book value.

The calculations produced by the valuation ratios are used to gain some understanding of the company's value. The ratios are compared on an absolute basis, in which there are threshold values. For example, in price-to-book, companies trading below '1' are considered undervalued. Valuation ratios are also compared to the historical values of the ratio for the company, along with comparisons to competitors and the overall market itself.
Fundamental Analysis: Conclusion

  1. Fundamental Analysis: Introduction
  2. Fundamental Analysis: What Is It?
  3. Fundamental Analysis: Qualitative Factors - The Company
  4. Fundamental Analysis: Qualitative Factors - The Industry
  5. Fundamental Analysis: Introduction to Financial Statements
  6. Fundamental Analysis: Other Important Sections Found in Financial Filings
  7. Fundamental Analysis: The Income Statement
  8. Fundamental Analysis: The Balance Sheet
  9. Fundamental Analysis: The Cash Flow Statement
  10. Fundamental Analysis: A Brief Introduction To Valuation
  11. Fundamental Analysis: Conclusion
RELATED TERMS
  1. Relative Valuation Model

    A business valuation method that compares a firm's value to that ...
  2. Absolute Value

    A business valuation method that uses discounted cash flow analysis ...
  3. Present Value - PV

    The current worth of a future sum of money or stream of cash ...
  4. Discounted Cash Flow (DCF)

    Discounted cash flow (DCF) is a valuation method used to estimate ...
  5. Discounted After-Tax Cash Flow

    An approach to valuing an investment that looks at the amount ...
  6. Price to Free Cash Flow

    A valuation metric that compares a company's market price to ...
RELATED FAQS
  1. How do I value the shares that I own in a private company?

    Share ownership in a private company is usually quite difficult to value due to the absence of a public market for the shares. ... Read Answer >>
  2. How do I calculate free, discounted and operational cash flow in Excel?

    Take a quick look at how you can calculate a company's operating cash flow, free cash flow and discounted cash flows using ... Read Answer >>
  3. What are some ratios I can use the operating cash flow ratio with?

    Understand the importance of a company's operating cash flow. Learn about some of the financial ratios that use the operating ... Read Answer >>
  4. Besides free cash flow to equity (FCFE), what are other metrics for estimating a ...

    Learn about metrics used to calculate a company's value, including capital expenditure, revenue expenditure, price-to-earnings ... Read Answer >>
  5. What is the difference between book-to-market ratio and cash flow to price?

    Learn about the differences between the book-to-market ratio and cash-flow-to-price ratio, as well as in which contexts investors ... Read Answer >>
  6. Why would you take DCF into account rather than simply projecting future revenues?

    Learn what discounted cash flow analysis is and why it is considered a better equity valuation tool than simply projecting ... Read Answer >>

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