## Sunday, August 22, 2010

### More on Valuation - Intrinsic Worth

How much are stocks worth? They are worth the present value of their future cash flow. That value is determined by the amount , timing and riskiness of the cash flows.

To calculate the intrinsic worth of a stock, some concepts are needed. First, the discount rate (R) which equal to the time value of money plus a risk premium. The risk premium is tied to factors like size, financial health, cyclicality and competitive positioning of the firm under evaluation. Finally, there is a very long term estimated growth rate of cash flow (g).

To calculate the intrinsic worth, follow five steps:

1) Forcast free cash flo (FCF) for the next 10 years

2) Discount these FCFs to reflect the present value
Discounted FCF = FCF for that year / (1+R)^n
(where R is the discounted rate and n is the year
being discounted)

3) Calculate the perpetuity value and discount it to the present
Perpetuity Value= FCF(n) * (1 +g) / (R - g)
Discounted Perpetuity Value = Perpetuity Value /
(1 + R)^n

4) Calculate total equity value by adding the discounted perpetuity value
to the sum of the 10 discounted cash flows in step 2
Total Equity Value = Discounted Perpetuity Value + 10 Discounted Cash
Flows

5) Calculate per share value by dividing total equity value
by shares outstanding
Per Share Value = Total Equity Value / Shares Outstanding