Valuation and what a price implies.

Enterprise value

What the whole business is worth, debt included. Market capitalization plus net debt.

Equity is a residual claim. It is what remains of the business after lenders have been paid, which is why enterprise value is the honest measure when comparing two companies financed differently.

It also explains why levered equity moves so violently. If enterprise value falls 30% while the debt stays fixed, the entire decline is absorbed by a smaller slice: shares worth $8.00 become $4.40. The business fell by less than a third. The equity fell by far more.

Worked through: leverage is a calendar, not a ratio.

Normalized earnings

What a business earns in an average year, with one-off items and cycle extremes stripped out. The honest denominator.

Reported earnings are an output of wherever a company happens to sit in its cycle, so any multiple computed off them is a measurement of that moment rather than of value. Normalizing means asking what margin this business earns across a full cycle, which usually takes ten years of history and about twenty minutes.

It changes answers rather than decorating them. A stock trading at a fair 15 times normal earnings shows 7.0 times at the peak and 70.6 times at the trough, looking like a bargain exactly when it is most dangerous.

The full cycle, priced: a low multiple is not a cheap stock.

Reverse DCF

Running a valuation backwards: instead of asking what a company is worth, ask what the current price already assumes.

A normal discounted cash flow requires you to forecast, which means the answer is mostly a reflection of your own assumptions. Reversing it removes that problem. Take the price as given and solve for the growth and margins required to justify it.

That converts an unanswerable question into a checkable one. You no longer have to predict the future, only judge whether the future the price implies is plausible, and how often this company has managed anything like it before.

How to run one: ask what the price assumes, and the DCF model.

Dilution

Your claim on a business shrinking because the company issued more shares.

Earnings per share can fall while profit rises, if the share count rises faster. Dilution is usually gradual, arriving through stock-based compensation, and is easy to miss because no single quarter looks dramatic.

It is most damaging when a company is forced to issue at a bad price. Raising $150.0M at $4.40 rather than $8.00 means issuing 34.1M shares, diluting existing holders 25.4%. The business can recover completely and the claim on it never does.

The gradual version: non-cash is not free. The forced version: leverage is a calendar.

Margin of safety

The gap between what you pay and what you think it is worth. Protection against being wrong.

Every valuation rests on assumptions that could be mistaken, so the discount is not a bonus. It is the allowance for error, and it is the only defense available against the fact that you cannot check your reasoning until afterwards.

It also has to be sized against how wrong you could be. A stable business with predictable cash flows needs less of one than a cyclical whose earnings can move ten times, or a levered company where a refinancing date decides the outcome.

What the price has to assume before you can size it: ask what the price assumes.

Terminal value

The single number standing in for everything after the explicit forecast ends. Usually most of the answer.

A discounted cash flow forecasts cash flows for some number of years, then needs a way to value the business continuing beyond that. Terminal value is that placeholder, most often computed as a perpetuity growing at a chosen rate and discounted back.

The uncomfortable part is how much weight it carries. On a ten year forecast it is typically around 60.2% of the total value, and on a five year forecast nearer 75.6%. The decade of careful modeling everyone argues about is the minority of the answer.

It is also the most sensitive part. Across a plausible range of perpetual growth rates and discount rates, the same company values from $1,899M to $3,300M, a spread of 74%. A useful sanity check is to divide terminal value by final year cash flow and ask whether the implied perpetual multiple is one you would actually pay.

The full argument, including why this is a criticism of our own primary method: most of a discounted cash flow is a number you made up.

Earnings yield

The price to earnings ratio turned upside down. Earnings divided by price, expressed as a percentage.

A stock at 20 times earnings has an earnings yield of 5%. The information is identical, but the framing changes what you compare it against. A multiple invites comparison with other multiples. A yield invites comparison with a bond, a savings account, or the return you need.

That comparison is the point. When government bonds yield more than the earnings yield on equities, you are being asked to accept more risk for less return, and the question of what you are being paid for that risk becomes concrete rather than theoretical.

The same warning applies as to any multiple. The denominator is an output of the cycle and of whatever one-time items landed in the period, so an earnings yield computed on flattered earnings is flattered too. Normalize first.

Why the denominator lies: a low multiple is not a cheap stock.