eli5 How do most stock analysts go about valuing a company?
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There are a couple things they look at. The first thing you look at is the assets and liabilities on the balance sheet. That is the book value of everything the company owns and all the money it owes. This sets a floor on the value of the company, even if it stopped doing business tomorrow you can at least sell all it’s buildings and equipment for the book value (in theory realistically it will be less than the book value). Once you have that floor set you look at the companies earnings, usually it’s EBITDA (Earnings before interest taxes depreciation and amortization) and multiply that by about 10 or so whatever is industry standard to get a value for the company. What makes this tricky is you don’t just want to know what todays EBITDA is you want to guess what it will be in a few years. That’s how some companies get really over valued, people start thinking Thneed demand is going to go through the roof and the company will 5X it’s EBITDA in 3 years, so the reasonable stock price is actually 30x it’s current EBITDA.
There’s two way to look at it:
* What would anyone pay for it right now ? So you look at multiples of comparable companies (the trick here is to define “comparable”) and go with that.
* How much cash flow this company will produce in the future (ultimatly ending up in vlaue for shareholders)?
* You need a detailed business plans, a lot of assumptions
* You actualize them with their cost of capital: that’s how much it ‘s worth under that specific scenario
* you remove the debt that is owed to the banks, and what’s left is the value of Equity.
THe seconc case show how important assumptions are. If everyone thinks the company will grow 10% and you think they’ll grow 5%, you won’t have the same value…
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