Some Methodology Behind how to Value A Company

Why do valuations fail?

Problem 1: Most people when they value a company have a perception on how to value a company. This includes everything they've ready, heard, and prior knowledge. The most obvious irony to this is that the MORE that individual knows, the stronger the preconceptions. This naturally leads to a high value being placed on companies with strong existing pre perceptions by the investors.

Here's proof: If you tell me who is paying you to evaluate a company, and how much they get paid, I can without a doubt in my mind tell you youu which direction the bias will be and how much. This is fundamental. When a valuation comes across our desks, there needs to be two questions.

Who did this valuation?

1) How much did they get paid? and WHO paid them to do this valuation. If an investment banker comes to you with an valuation based on his hidden agenda to take the company over, his value of the company will obvious be suited.

2) Computers, models, indicators, all allow us to feel like we're using numbers that will tell the future. This isn't the truth. Valuations involve quantitative numbers, and need to be internally valued by your own bias. The best ironic part of a valuation, is that the more you are unsure about the valuation of a company, the higher the chance that company will deliver upside returns that outperform competitors in the same market sectors.

If you make a model bigger, it get's better. As models are built, remember that the inputs are human made. Two things happen when a model becomes to complex. After a certain point, the model runs you. You also get input fatigue, and more or less just noise.

If you can value a company with just 3 metrics, stick with that--less IS more.

In each approach , it assumes that market makes mistakes. If market never makes mistakes, there would be no value for us as traders, because it would mean that all asset classes are set to their true equilibrium, which as we know is not possible. However, the key takeaway is that each of these approaches makes different assumptions about how and why the market has made these mistakes.

3 approaches to valuation.

Intrinsic valuation: a company being based on discounted cash flow estimation (not the only one ). Put simple: the value of this asset is derived from free cash flow, nothing more. The key though is this phase is all about the business. You're trying to simply value a business based on its cash flows. Cash flows, discount rate reflecting the risk in these cash-flows, and then the life of the asset. You assume markets make mistakes and that these mistakes are corrected over time. This means that using this valuation technique means that you need a longerterm-horizon.

Relative valuation:
comparing similarly priced assets, that can then be used as a benchmark. For example., "based on how B is doing, we can assume company A has value. If you break down relative valuation here's what we see: a scale measure of price. This being said, finding something that is comparable is key. You need to control for differences (scale down multiples, look for comparables, scale the difference). make sure you are comparing similar companies within the same subject of an individual industry.

The last method (and the one I use) is applying option pricing models with valuation models using contingent cash flows. This means that value within the valuation is taken collectively. You assume that the market is right among most of the companies in an asset classes excluding minor outliers, and that time will correct that assets price, similar to above. Using these models to value businesses with option like characteristics. Options derive there value from a contract with a limited life. For example, an oil company with undeveloped reserves. There is an option for the company to choose to do so or not, but only if the price is right.

This includes companies with viable patents in the future, or a company in a money losing company, this would be arguable that you are buying an asset based on the optional pricing method.


nice job keep posting
Good job
TayFx Tiavis
@Tiavis, thank you kindly
Keep going
TayFx NicoleLomazowLowe
@NicoleLomazowLowe, I'll never stop
Please give some more directions to evaluate a company.
TayFx kennethNipperCRPC
@kennethNipperCRPC, sure, what sort of stuff would you like me to include?
@TayFx, this is a great way of doing things for long term investors or even pension funds. with option one you see how much money is flowing in and out of the Company. i was looking at a 10K for i think TTOO and the CEO had a super inflated salary with a crazy bonus. the company stock was has not done well and they havent really had a profitable year in a long while. But, he got like a perfromance bonus of 85% of i think his 500K - 600k/ year salary. i was thinking to myself "you got a bonus to suck at your job?!?!" I was tipped off by the cash flow statement. when i look at a 10k the first thing i look at are the risk factors, and then any assests they own like intellectual property mainly. then toward the end of my scannnig i will finally look at the cash flow statements. and that particular company is a great company it has all the ingredients to be a great company but their leadership sucked. they got a new CEO so we shall see. Option 2 i think is a risky way of doing things. its a great way to get sucked into a trap. for example lets say there is a soda company youre wanting to purchase and you look at Coke or Pepsi to see how well theyre doing and think this is a great oppritunity only to realize that those are the two outliers of the industry. I am assuming the last option is looking at the traditional SWOT analysis, looking at free flowing cash statements and then looking at intellectual property, physical assests, stocks and what not all the while taking into consideration with any bonds, or open contracts that either need to be rolled over into a new contract or be delievered on. you see this type of bond/contract fulfillemnt in the agriculture sector of the market like corn, wheat, or soybeans etc. even though im not a stock player, stick with mainly FOREX, when i do look for a stock company to potentially incvest in, like you, i go with option 3. great post man!
And from technical perspective prices after breaking the accumulated area with big green candles retraced to give the patients wise people a nice chance with big red candle with lovely price action to ride the wave to upside
TayFx chunkuya1000
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