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What is Abnormal Earnings Valuation?
The abnormal earnings valuation method is one in which the future cash flows of a business are given significant weight in a valuation, especially when there are not many hard assets to use for valuation purposes. If a company is rich in human capital or has significant cash flows, whether or not it has many hard asset or book value, the Abnormal Earnings Valuation Model can be the most useful method for arriving at an accurate valuation of a business and its stock. Continue reading...
What is the Dividend Discount Model?
The Dividend Discount Model (DDM) is a method for valuing a stock, that looks at expected future dividend payouts and adjusts to present value. If the calculated value is less than the current trading price, the security is thought to be undervalued. The DDM is helpful as a tool but should not solely be used in valuation calculations. Perhaps its biggest flaw is that future dividends have to be projected and assumed, which is a far-from-certain practice. Continue reading...
What is the Price to Cash Flow Ratio (PCFR)?
The Price to Cash Flow Ratio (PCFR) is a valuation measure that looks at a company’s stock price relative to its cash flow per share. Generally speaking, the lower the ratio, the better chance the company is undervalued - it basically means the company produces a lot of cash flow relative to how much it costs to acquire a share on the open market. A very high PCFR indicates that a company is trading at a high price relative to the amount of cash flow it produces. Start-up technology companies, for instance, would generally have high PCFRs because they may not produce high levels of cash flow in early stages, but investors may bid up the price in anticipation of future growth. Continue reading...
What is a Run Rate?
Run rate is a term that can be applied to a certain type of accounting and management estimation or to the depletion of equity options. The first kind is when a current metric (such as sales revenue for a quarter) is assumed to extend out to the end of the year or accounting period for estimation or valuation purposes. The second kind uses the average dilution from the past three years, generally, to show the effect that convertible securities are having on the share price of a company. Continue reading...
What is the Price to Sales Ratio (P/S Ratio)?
The Price to Sales Ratio, also known as the PSR, is a valuation metric that looks at a stock’s market price versus its per share revenue. Alternatively, you can calculate it by dividing a company’s total market capitalization by its total revenue in the most recent fiscal year. The ratio indicates how much value (how much investors are willing to pay) is placed on each dollar of revenue generated by the company. Continue reading...
What is the security market line?
The Security Market Line (SML) is a visualization of the Capital Asset Pricing Model (CAPM) and shows the theoretical relationship between risk and return between securities and the entire market. The SML is plotted on a graph bound by an x-axis, which represents Beta (volatility above or below the market average), and a y-axis, which represents the rate of return. Beta is a volatility indicator that measures how many changes in price, and by how much, a security experiences over an amount of time. It describes whether the risk associated with a particular security is above or below the average of the market (or a more specific index), where 1 is a correlation with the market, and numbers above or below describe increased or decreased volatility, respectively. Continue reading...
What is an Adjunct Account?
An adjunct account increases the valuation of a liability account. An adjunct account is commonly used when accounting for a bond issue sold at a premium. The par value of the bonds sold is included in one line as a credit to Bonds Payable, and the increased premium in placed in another line as a credit to Premium on Bonds payable. The technical term for the account into which a discounted bond’s discount is placed is a Contra Account. Continue reading...
What is Enterprise Value?
Enterprise Value is the total cost to acquire a company. The Enterprise Value of a company is the amount that would have to be paid for full ownership of it, which would include market capitalization (price per share x shares outstanding) + net debt (all liabilities - cash and equivalents). Market cap alone is technically just shareholders equity, and not capital from debt, so Enterprise Value adds that in for consideration. Enterprise value is the numerator in EV/E (Enterprise Value over EBITDA), a very common valuation ratio. Continue reading...
What is coefficient of variation?
A coefficient of Variation is a statistical measure of expected return relative to the amount of risk assumed. It’s also known as “relative standard deviation,” which makes sense since that implies that your expected risk is adjusted based on the expected return. You can easily calculate the Coefficient of Variation by dividing the standard deviation of the security by its expected return. Continue reading...
What is the Price/Earnings to Growth Ratio (PEG Ratio)?
The Price/Earnings to Growth Ratio (PEG Ratio) is used to determine a company’s value relative to its expected growth. The PEG ratio can be calculated by dividing a company’s P/E by its annual earnings per share growth. A lower PEG ratio may indicate that a company is undervalued relative to its expected growth, and a general rule of thumb is that a PEG ratio below 1 is favorable. Continue reading...
What is EBITDA?
EBITDA stands for Earnings Before Interest, Taxes, Depreciation and Amortization, and is used as a ballpark figure for where the company’s earnings are without these expenses. It gives a picture of the total operating revenue of a company with the expenses that are related to financing decision and the tax environment left out. Accountants can calculate EBITDA by taking net income (earnings, or operational earnings) and adding interest payments, tax obligation, depreciation of hard assets, and amortization of intangibles back into it. Continue reading...
What is Terminal Value?
The "end" value at a specified date in the future of an investment or cash flow. Terminal value is a term used in value calculations looking forward toward the future value of an asset or cash flow, and also in calculations which start with the Terminal Value and depreciate the asset over the intervening years until one arrives at the Present Value. Can be used in calculations regarding a business, an index, a cash flow, or an asset. Horizon Value is a synonym, and is perhaps better suited to describe the way the calculation chooses a time horizon of a specific number of years, but otherwise uses the same numbers in an equation that will estimate the value if the business or index went on growing at the same rate into perpetuity. Continue reading...
What is a Value Stock?
Value Stock is a stock whose price has been deemed a value buy because of underlying fundamentals, book value, and projected earnings. Prices for stocks can temporarily be pushed around by sentiment, index tracking fund purchases, news and political effects, et cetera, and often the prices on very good and well positioned companies become undervalued as part of larger movements that overlook their inherent value. Continue reading...
What is Times Interest Earned (TIE)?
Times Interest Earned (TIE) is also known as the interest coverage ratio, is a cash-flow analysis that compares the pre-tax earnings of a company to the total amount of interest payable on their debt obligations. A healthy ratio indicates that a company will probably not default on loan repayments. To compute this ratio, divide a company’s annual income before taxes by their annual interest payments on debt obligations. This ratio is not concerned with the actual principal due on loans since the principal amount is already pegged to some of the assets on the books of the company, and other fundamental equations will already factor that in. Continue reading...
What is Appraisal?
Appraisal is a valuation conducted by a certified professional to assess the value of property, especially real estate. Appraisals are an important service in the real estate industry in particular. Where mortgage loans are being taken out from banks, including original mortgages, refinancing, home equity loans and lines of credit, as well as in business and estate valuations, the property appraisal will play an important role. Continue reading...
What are Consolidated Financial Statements?
Consolidated financial statements are required when one company owns a controlling interest in another company. They must adhere to the same accounting principals as a the financial statements for a single company. Some detail tends to be lost if the parent company and subsidiaries have very different operations. If a company owns more than 50% of another company, their financial statements will be consolidated into one, according to GAAP. Up to that point, the interest in another company can be accounted for using cost-method or equity-method accounting. Continue reading...
Who is an Assessor?
An Assessor is a government employee who finds the value of properties and other assets for tax and insurance purposes. The assessor’s office is responsible for coming up with the assessed value of real estate property in a municipality, for the purpose of assessing property taxes. Assessors may have other roles, but this is the main one. Considering that assessors have to determine a value of every piece of real property in their district, it can certainly be an overwhelming task. Continue reading...
What is Intrinsic Value?
Intrinsic Value is the value of a security which is “built into it.” Both options and stocks have it, but it is different for each. Options and stocks have intrinsic value. For options, the intrinsic value is easy to compute, if the option is in-the-money. It is the difference between the strike price of the option and the market price of the underlying security. If an option is out-of-the-money it has no intrinsic value. Continue reading...
What is Abandonment Value?
The Abandonment Value is the salvage value left if a capital project is stopped short at an unknown time. Authors Robichek and Van Horne (1967) offered a very concise argument for the importance of including an Abandonment Value in the calculations leading to a company decision to undertake a long-term capital project. The calculation is useful for risk assessment, and tries to find the value at which project assets could be liquidated if the project could not be continued for some reason. Continue reading...
What is Face Value?
Face Value is the nominal value of a security or currency as written/stated by the issuer. It may vary from market price, since for securities like stocks the price is heavily influenced by supply and demand. In the case of bonds, interest is usually calculated as a percentage of face value. Also for bonds, the face value is generally equal to the par value (principal), usually the $1,000 paid to the holder at maturity. Continue reading...