1 0 Tag Archives: balance sheet
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How To Estimate The Value of a Stock

If you are an investor, it’s likely that you take many different things into account when researching a company. You might research a company’s past performance, its financial ratios, competitive position, product lineup, and many other factors that could potentially contribute to its success or failure.

Let’s assume you’ve found a company that you’d like to invest in. After doing your research, you can see that it is strategically positioned with a competitive moat, has a great product lineup, has been extremely profitable, and has a strong balance sheet.

Congratulations! You’ve already finished the difficult part of the process. But now that you’ve decided that you like the company, how can you determine if its stock is priced reasonably? You’ve just stumbled upon one of the most fundamental questions of investing.

Timing is one of the most crucial elements of investing, and I would venture to guess that most experienced investors would say that it is the most difficult part. After all, isn’t the goal to buy a stock when it is a good value and before it increases in price?

As Warren Buffett says, “If a business does well, the stock eventually follows”. By this, he means that if you buy a stock in a company at a temporarily low price, it’s not clear exactly how long it will stay at the lower price, but its price will eventually follow the company’s performance.

But how can you know if a stock is a good value, or at the very least, priced reasonably?

There are many valuation methods that investors use to calculate stock value. We will focus on one of them. It is called the intrinsic value calculation method, and involves estimating the value of a stock based on its projected earnings and dividends.

Most investors are concerned about a stock’s earnings, and more specifically, its earnings per share. This is because most investors like to see that an increasing amount of a stock’s earnings in relation to his or her stake. As the amount of earnings per share increases, the more likely it becomes that the company will increase its dividend.

It’s not an exact science, but the process of calculating intrinsic value has three main components. Step one is to conservatively estimate how much a company will earn per share in net income and dividends over your investment horizon. The second step is to calculate a future stock price by how figuring out how much investors are likely to pay in the future for the earnings that you’ve estimated.

Finally, once you have estimated the future value of the stock, you can then find the present value of the future stock price that you have calculated based on the estimated ROI and your investment time horizon.

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01. Jan, 2011
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EBITDA is an acronym for earnings before interest, tax, depreciation and amortization. Investors, owners, business managers need to understand profitability. While it may be possible to understand profitability for a business, they would also like to benchmark against trends, other companies in the same industry, different geographical areas etc. Each company is structured differently. This makes profitability ratios difficult to compare. To enable comparisons, therefore, EBITDA has evolved. Each business structure may be different. Let us see what impact these differences will have on the profitability.

The capital invested in any two businesses may not be the same. Some businesses have more owned capital and others may have more of debt. Interest is paid on debt. So while one business may not have interest expense, the other might have interest expense. This has nothing to do with profitability from operations. The interest expense is eliminated to enable a fair comparison.

The tax structure of any two businesses may not be the same. The tax structure depends on a number of factors such as the ownership structure, geographical location, incentives provided by various levels of the government for different businesses. A fair comparison may not take place unless impact of all these items is eliminated.

Each business may also have different levels of automation. Automation requires more of capital expenditure that will also require a higher level of depreciation expense. The age of the business also determines the depreciation expense. Older capital equipment might have a lower level of spend and therefore lower depreciation. There are various intangibles that a company may have on its Balance sheet such a goodwill etc. Goodwill needs to be estimated and amortized once a year. This might result in swings in profitability between different companies and also between different years for the same business.

Therefore, while comparing profitability, it makes sense to eliminate the impact of these items that could be due to a non – operational reason. EBITDA serves this purpose.

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11. Sep, 2010