Question

Assume a company you are analyzing is expected to grow its earnings and dividends at a constant rate in the foreseeable future (forever).  How will you find the intrinsic value of your stock? This answer requires multiple steps and concepts

Answer 1

Intrinsic value is the anticipated or determined value of a company, stock, currency or product determined through fundamental analysis. It includes tangible and intangible factors. Intrinsic value is likewise called the real value and might possibly be equivalent to the current market value. It is likewise referred to as the price a rational investor is willing to pay for an investment, given its degree of risk.. Basic Formula

The fundamental or the intrinsic value of a business or any investment resource is generally considered as the present value of all future cash flows discounted at an appropriate discount rate.

In this way, the most "standard" approach is similar to the net present value formula:

Where the images have the typical meaning shown underneath –

NPV = Net Present Value

CFi = Net cash flow for the ith period (for the first cash flow, i = 0)

r = interest rate

n = number of periods

Breaking Down the Intrinsic Value

The intrinsic value can be registered by value investors using fundamental analysis. In this strategy, an analyst needs to take a gander at both the qualitative factors and quantitative factors.

The qualitative factors include the business model, governance, and market factors, whereas the quantitative factors, for example, financial statement analysis/The registered intrinsic value is then compared with the market value to determine if the advantage is overvalued or undervalued.

Risk Adjusting the Intrinsic Value

The risk of adjusting the cash flow is subjective. It is a combination of both art and science. There are two primary strategies:

1. Discount Rate

Under this approach, the analyst generally utilizes a company's weighted average cost of capital. The weighted average cost of capital as a rule includes the risk-free rate (derived from the government bond yield) along with a premium dependent on the volatility of the stock multiplied by an equity risk premium. The approach depends on the fundamental theory that if a stock is more volatile, it is a riskier investment and an investor ought to improve returns. In this way, in this situation, a higher discount rate is utilized, and it reduces the cash flow value that is normal in the future.

2. Certainty Factor

In this technique, a certainty factor, or probability is assigned to each cash flow or multiplied against the entire net present value (NPV). This strategy is a means of discounting the investment. In this technique, the risk-free rate is utilized as the discount rate as the cash flows are risk balanced. For instance, the cash flow from a government bond accompanies a 100% certainty. In this way, the discount rate would be 7 percent.

Therefore, the discount rate is equivalent to the yield rate. Now, expect cash flow from a high growth company that has 50% probability factor assigned, a similar discount rate can be utilized as the risk related to the high-risk resource (the high growth company for this situation) is already factored in with the probability number.

Method of Valuation

While valuing a company as a going concern, there are three main methods utilized by industry practitioners:

Comparable company analysis, and

Precedent Transactions

DCF analysis

Let us see every one of the methods quickly:

Method 1: Comparable Analysis

The method of near analysis is otherwise called trading products or friend bunch analysis or value comps or open market products. The method utilizes the technique of relative valuation where an analyst looks at the business (or advantage for) be valued to other comparable companies by studying trading products, for example, P/E, EV/EBITDA, or different other proportions. The method gives a discernible value to the business dependent on what other companies are worth.

Model, if a company An exchanges at 10x P/E proportion and company B has earnings of Rs. 2 for every offer, the value of each load of company B is worth at Rs 20 for each offer (assuming the companies are entirely comparable).

Method 2: Precedent Transactions

The method of precedent transactions is like relative valuation in which an analyst analyzes the company to be valued to other businesses that have been recently sold or gained and belongs to a similar industry.

These transactions are put to use to evaluate the value of the company.

Method 3: DCF Analysis

DCF likewise is known as the Discounted Cash Flow (DCF) method is the most utilized way to deal with show up at the intrinsic value. In this method, the analyst forecasts the future cash flow of the business and discount it to present value by using the company's Weighted Average Cost of Captial (WACC