P / E and future cash benefits (linkage of income and comparative analysis) - Investments

P/E and future cash benefits (linkage of income and comparative analysis)

Assuming that the company generates the same cash flow values ​​at the same time and the flow is infinite, the business evaluation formula will take a very simple form

where FCF - free cash flow (since capital needs can be covered by depreciation charges, and if there is no growth in revenue, there is no need to increase working capital, in fact, it is a question of post-tax operating profit); k is the discount rate that reflects the level of risk of the projected cash receipts, in fact, it should be a question of the capitalization rate.

The ratio ( l/k) can be treated as a multiplier (M) of profit.

Valuation of the company as an investment asset = Average multiplier х х Average normalized profit.

The resulting product reflects the value of the company as a functioning set of material and intellectual assets. Since a company that actually operates on the market often has dormant assets, as well as a stock of net working capital, the correct formula for assessing the business should be written as follows:

V = Mx Profit + Net working capital + Non-functioning assets.

To get the final value of the cost, you will need to estimate separately non-performing assets, as well as net current assets and add their value to this result.

Assuming that the internal (true, true) value of a company's equity is equal to its market capitalization ( MS 0 or P ), and as a benefit stream, consider net profit (N1), you can get the popular multiplier "price-earnings" ( price-earnings ratio), or "multiple profit":

The multiplier P/E states: the cost of the company's equity is equal to the capitalized estimate of the annual net profit. The fair level of the multiplier depends on the required yield, and hence on interest rates in the market and risk. The more expensive the money in the market, the lower the value of the multiplier.

The second fundamental factor that determines the value of the multiplier is return on equity (ROE).

Such a statement suggests that the company is developing steadily, there is no significant progress in accepting investment projects or in payments to owners. Price-earnings multiplier & quot; is a simplified representation of the discounted cash flow method in the absence of growth.

It should be understood that in this case the capitalization rate is not equal to the discount rate in the discounted cash flow method (DCF), this is the discount rate adjusted for the rate of long-term growth. The capitalization rate obtained from the high multiplier P/E, shows a low quantitative value and signals expectations of a high long-term growth of the company.

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