As value investors, we tend to live in the domain of spreadsheets. Value investing is the strategy of finding stocks that are undervalued relative to their intrinsic value, or inherent worth. The intrinsic value of a stock is the the sum of all cash flows that a company will generate in its perpetual existence, discounted at the weighted expected return of the debt and equity investors in the company. Traditionally, investors have used Microsoft Excel to build complex discounted cash flow (DCF) models to estimate the cash flows generated by the company and a weighted average cost of capital (WACC) model for estimating the weighted expected return for the firm. This practice is one of the primary activities of any financial/investment analyst and there is even a Financial Modeling World Championship to showcase the best of the best at this art.
While there are many reasons to build complex financial models in Excel, the intrinsic value of a company’s stock can be calculated much more simplistically using a standardized system. This is what we’ve created at Intrinio. Our web application brings the flexibility of Excel onto the web without the complexity of a having to manage a spreadsheet filled with calculations or bad data. This makes it very easy for performing scenario testing, value driver analysis, or sensitivity testing. Merging this with an easy-to-use user interface, Valuation is exactly what value investors need to bring their investment analysis to the next level.
Because of the difficulty of managing financial models in Excel, most value investors tend to focus on Valuation ratios, such as the Price-to-Earnings ratio, the Price-to-Book ratio, the Enterprise Value-to-EBITDA ratio, the Enterprise Value-to-Revenue ratio, etc. Comparing these valuation ratios to those of similar companies, industry aggregates, or the S&P 500 aggregate, along with other performance metrics provides an indication of whether a company is over- or under- valued. Valuation ratios are in essence a single period cash flow perpetuity. A Price-to-Earnings ratio can be disaggregated to equal 1 / (Cost of Equity – Long-term Growth Rate) and the intrinsic value equal to next years expected EPS multiples by the calculated Price-to-Earnings multiple.
For example, Apple’s cost of equity is 8.66% and has an expected long-term growth rate of 2.47% (1 / (8.66% – 2.47%)) equals a Price-to-Earnings multiple of 15.97x. Based on Zack’s EPS Wall Street Consensus Estimate of $8.51 for the current year, the intrinsic value of Apple based on this basic model is $135.90, which is approximately 6% above the price of Apple of $127.39 as of April 6th, 2015.
While this simplistic model is nice for giving an approximate intrinsic value quickly, in many cases a single period perpetuity is not an accurate reflection of the company’s strategy and earnings generation. For example, during a recession, a single period perpetuity would likely understate the intrinsic value of the company, given an expected rebound in revenues and margins in the coming years. A company may be making large capital expenditures in the current year, which are expected to generate greater revenues and margins in the future. Therefore, to assess the company’s intrinsic value, a focus on cash flow generation based on the current company’s strategy, the industry competitive landscape and the macroeconomic environment is much more complex than a simple approximation of the Cost of Equity and the Long-term Growth Rate.
With Intrinio’s Valuation Webapp, we allow you to estimate the revenue growth, net operating profit margin after tax, and the invested capital turnover to forecast the free cash flows to the firm for the next five fiscal years. We also allow you to change the spread on the long-term debt to assess the riskiness of the debt and the company specific risk premium to assess the riskiness of the equity above or below that of a modified capital asset pricing model cost of equity. These assumptions combine to create a discounted free cash flow to firm intrinsic value model, which can help you calculate the intrinsic value of any company. Because of how simple it is to use Valuation, you can easily perform scenario testing, such as understanding what Apple is worth if there were a recession in 2016. The flexibility of this web application provides value investors an invaluable tool to make better investment decisions. We have taken the complexity of an Excel valuation model onto the web, while providing a user experience that makes it fun and easy to really understand how and why a company offers a high probability of a good investment opportunity.