Course
How to value a stock, from the statements to a fair value.
Ten short lessons. One made-up company. Every step from the annual report to a value per share, with every figure from one model.
EDUCATION, NOT ADVICE ·
The example company. Example Co. is a made-up company. A model script calculates every figure in this course, so you can check each one. The method works the same way on a real company.
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How the course works
Every lesson uses the same made-up company, Example Co. The first lesson builds its three financial statements. Each later lesson takes one step toward a value per share.
A model script calculates every figure. It checks that the statements tie, that the DCF agrees with the formula in steady state, and that the reverse DCF returns the price.
The lessons
- Three statements tell one story. The income statement, the cash flow statement and the balance sheet.
- Net income, free cash flow and owner earnings are three different numbers. Stock pay, working capital and equipment.
- Growth adds value only when new capital earns more than the hurdle. Return on capital, reinvestment and the growth identity.
- The discount rate turns future cash into today's dollars. Present value, the capital asset pricing model and the hurdle.
- A DCF adds ten years of cash flow and a value for the rest. Ten years of cash flow, discounted, plus the rest.
- Most of the value is in the years after year 10. The constant growth formula and what it hides.
- A reverse DCF asks what the price already assumes. Turn the price into a claim you can test.
- A multiple is a DCF with the assumptions hidden. P/E, EV/EBIT, the yield, and what each one assumes.
- Value per share depends on what happens to the shares. From the whole business to one share.
- A fair value is a range, so leave a margin of safety. Bull, base and bear cases, and the price to pay.
Example Co. on one page
| Measure | Example Co. |
|---|---|
| Revenue | $1,000 million |
| Operating margin | 18% |
| Net income | $137.5 million |
| Owner earnings | $90.1 million |
| Return on invested capital | 28.4% |
| Hurdle | 9% |
| Our value per share | $23.92 |
| Price | $30.00 |
| Growth that the price needs | 15.0% |
The price is above our value. Lesson 7 shows what the price assumes, and lesson 10 shows the price that we would pay.
Also in the field guide: the financial statements
course, the options course and valuation
entries. Start here: lesson
1.
Sources
- SEC, How to Read a 10-K, for the three financial statements in the annual report.
- William F. Sharpe, Capital Asset Prices: A Theory of Market Equilibrium under Conditions of Risk, The Journal of Finance, 1964, for the capital asset pricing model.
- Myron J. Gordon, Dividends, Earnings, and Stock Prices, The Review of Economics and Statistics, 1959, for the constant growth formula.