Beyond Earnings

4WHAT’S IT WORTH? VALUING THE FIRM

“The value of any stock, bond, or business today is determined by the cash inflows and outflows—discounted at an appropriate interest rate—that can be expected to occur during the remaining life of the asset.”

—The Theory of Investment Value, John Burr Williams

KEY LEARNING POINTS

• We outline how to calculate and forecast free cash flow to the firm (FCFF), which is central to performing a discounted cash flow valuation.
• We show how to value the terminal period of a forecast. A fade factor can be easily incorporated, making it possible to test the sensitivity of a valuation to changes in the rate at which profitability decays.
• The calculation and utility of economic profit (EP) in assessing economic performance and valuing a firm is described. For a given forecast, discounted FCFF and EP valuations yield the same result. We value Air Liquide and demonstrate its sensitivity to profitability fade.
• We step through the calculation of FCFF in the HOLT framework, and show how it can be estimated from a CFROI and asset growth forecast.
• Different profitability and growth scenarios are valued for Amazon, indicating that it is expected to maintain high profitability and fast growth.
• Air Liquide is analyzed through the lens of the HOLT framework.

We have outlined how to calculate a firm’s CFROI and analyze its historical operating performance. The next step is to calculate its intrinsic value based on profitability, growth, and cash flow forecasts. ...