Business Process Improvement – A Perspective
Development of Global Business Organizations, Multi National Corporations and the Corporate has always found a lot of academicians as well as the think tanks and Management Experts taking interest in analyzing the past, the present trends and prophesying the future trends. The study of growth of trade, the industries and the Organizations and the various […]
How Does ‘The Brand Called You’ Impact Your Employer Brand ?
Don’t miss on the best co-branding opportunity and let your personal and employer brands marry in harmony. True, your employer brand is one thing and your personal brand is the other. But as a top level executive, your personal brand can either be a promoter or detractor of your employer brand. What talent perceives about […]
Managing Employee Behaviour Problems
Remember, negative behaviour of a single employee can spoil the entire work culture. One needs to behave sensibly and follow the rules and regulations of the organization. It is mandatory for employees to maintain the decorum of the workplace and behave as mature professionals. Behaving irrationally at the workplace will not only spoil your relationship […]
The Solicitation Process
The disclosure statement is only the first step in the bankruptcy process. After the solicitation statement has been approved by the court, the ground is set for the negotiations to begin. This is a complicated stage. This is where stakeholders often form groups to connive against the others, and horse-trading takes place. The solicitation process […]
Is Tesla Close to Bankruptcy?
Elon Musk cracked an April 1st joke on his investors. He first claimed that Tesla had gone completely bankrupt. Later, he revealed that the company was still healthy and this was only an April fool’s joke. There are many investors and critics in the world who believe that this April fool’s joke may soon become […]
Estimating the value of equity stock of a company is not an easy proposition. This is because while estimating the stock price, all the data required to be used in the formula is not easily available. This is because the data is subjective.
It is really the analysts call on what they believe about the company, its future and based on it what numbers they input in the formula.
Also, slightly different numbers used in the formula give vastly different results. Hence, an analyst must have a strong basis to use any number as an input to the stock valuation formula.
Here are some of the common assumptions that will have to be made by the analyst during the stock valuation exercise:
As we learned in the previous article that stock valuation happens in two stages. The first stage is the horizon period for which exact cash flows are estimated.
Beyond the horizon period, the stock is considered to be a growing perpetuity and its value is estimated. But the question is “How big or small should the horizon period be and why?” We need to understand that the answer to this is not factual or based in proof.
Rather, the answer is based on subjectivity and convention. It is therefore entirely up to the analyst to decide what the horizon period should be?
An investor, however must be aware that changing the horizon period has massive effects on the stock valuation and must therefore watch out for the same.
After the horizon period is over, the stock is considered to be a growing perpetuity. This means that it will continue growing at a constant rate for the rest of its perpetual life.
This rate must be less than the required rate of return or else the answer we will receive will be infinite since it will no longer be a decreasing infinite series.
But, then what should that constant rate of growth be? This is again a matter of great subjectivity. Once again the analyst has a high level of discretion in this decision.
Also, this assumption is extremely important because the value of the perpetuity accounts for almost two thirds of the stock price in most cases.
A wrong assumption here can therefore give a significantly higher or lower stock price.
Apart from the expected returns to be realized from the venture, there is also a great deal of subjectivity regarding the riskiness that is involved in each case. It is obviously difficult to compare the riskiness across industries and across companies.
It is for this reason that estimating the cost of capital becomes relatively difficult. The market is efficient in pricing risk to a large extent.
The cost of equity capital is calculated using data from the market from the past few years. But once again, the riskiness can be very different depending on whether we select data for the past 10 years or for the past 15 years. This makes it a subjective decision too!
Also, the cash flows in the horizon period are estimated based on what the analyst thinks the future looks like in the next 5 to 7 years or whatever is the chosen horizon period. But, it is important to know that these estimates rarely end up being accurate.
Consider the fact that business cycles are largely unpredictable, and so are the moves by the competition and we understand why we can’t be relatively certain even about the future in the short and medium term.
The bottom line therefore is that any stock valuation is like a building which is standing on the pillars of its assumptions.
A good investor will therefore first investigate the soundness and reasonableness of its assumptions before deciding whether or not the stock valuation is fair.
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