Internal or fundamental value
When calculating the intrinsic value, the analyst tries to be realistic, without overestimating or lowering his estimates against the real market situation for supply and demand for shares. He has to consider the following factors that can affect the value of shares:
is the value of the firm's assets ( value of firm's assets.) The firm owns a variety of assets that can be sold, and proceeds from sales are distributed among shareholders. In assessing from the perspective of an ongoing business, this value is usually not taken into account, unless the firm discovers assets that are unnecessary for the continuation of the main production. But in this case too much is sold, and then the firm is evaluated. Although surplus assets can not always be sold within a limited time frame of the project under evaluation. In the latter case, this part of assets is included in the valuation;
- probable future interest and dividends ( likely future interest and dividends). If a firm must pay interest on a loan taken earlier or it has already declared a dividend payment, this affects the value of shares;>
- probable future earnings ( likely future earnings). This is the basis of the evaluation, the strongest factor;
is the likely future growth rate ( likely future growth rate). If the firm has a bright future of reliable, rapid and sustainable growth, its shares will definitely go up.
The internal cost is calculated in order to compare it with the current market value or with the price that a serious buyer offers for the firm. The market is imperfect, i. he does not immediately respond to changes in the firm, its shares may be both undervalued and overvalued. The main task of the analyst is precisely to detect inconsistencies of this type in order to profitably use them when buying or selling a firm, or in order to draw the attention of management and owners to the danger of financial seizure or bankruptcy. Situations of underestimation and reassessment of the firm by the market are of a temporary nature, therefore any valuation retains its correctness only for some time, the duration of which is unknown. Sometimes the market immediately reacts even to rumors about a particular firm, and sometimes does not recognize even very promising changes in firms for a long time. Why is this so? This is one of the problems that the financial science has not yet found an unambiguous answer.
The internal cost methodology does not always work because of the following main reasons:
- the market is imperfect, it does not always immediately respond adequately to changes in firms;
- there are firms whose success depends heavily on speculative factors and luck, and not on the depth and thoroughness of calculations.
Some businesses are as follows:
- Some firms are growing rapidly, and this growth is difficult to predict and evaluate, because it is influenced by factors such as fashion. You can recall the sales boom of the Rubik's cube and the electronic toy Tamaguchi. The whole world seemed to be screwed up because of them! And why?
- in the market from time to time there are new products, technologies and sectors. The economic parameters of these new phenomena for a certain time can not be formalized;
- Sometimes on the market "black Tuesdays, Thursdays and Fridays" occur, when stock prices of the whole market simply fly into the abyss for no apparent reason. It's good that these periods are relatively short, although unpredictable;
- it is not always cyclical fluctuations in the economy easily included in rational analysis. These phenomena are too multidimensional and complex;
- The revolutionary turmoil in some countries is able to shake and even change the structure of the market.
Anyway, the financial benefits associated with owning a firm or its part (shares), come from the following sources:
1) income or cash flows from basic operations;
2) income or cash flows from investments (interest from purchased loan instruments or dividends from unit instruments);
3) proceeds from the sale of assets;
4) proceeds from the pledge of assets;
5) sale of shares.
The main financial variables in assessing the value of these sources:
1) profit (income);
2) cash flows;
3) dividends or the ability to pay dividends;
5) revenue (revenue);
7) the cost of capital (the level of bank interest rates).
In some cases, the features of transactions for which an estimate is made and other additional circumstances can significantly affect the outcome. Among these factors:
- the size of the stake, from the positions and in the interests of which the firm is valued (controlling, dominant, significant, small);
- rights to participate in management (voting rights);
- the ability to easily, quickly and without significant losses sell shares, their liquidity, i.e. availability of an equipped and active market for them;
- legislative restrictions on operations with shares (on the size of the transaction, on the right to a controlling stake, antimonopoly rules, restrictions in the adoption of certain types of decisions, restrictions on the rights of foreigners, etc.);
- restrictions on property rights;
- restrictions on the change of the main activity of the company, etc.
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