Financial Statement Analysis

Chapter 1Company Valuation

Learning objectives

• Identify how an analyst places a value on a company.
• Recognize who uses company valuations.

Introduction

This section shows the correct method for determining the value of a company using the constant growth dividend capitalization model. Explanations are presented of (1) the variables defined in the model and (2) the valuation techniques and who uses them.

Why use a valuation technique?

Financial information is an important determinant of company value. We need to know how the financial statements affect company value.

• How does increased profitability affect company value?
  • Profitability is positively related to company value. That is, as a company becomes more profitable its value increases.
• How does increased growth affect company value?
  • Growth is defined as the company’s increasing ability to produce cash flows or profits. Growth is positively related to company value.
• How does increased risk affect company value? Liquidity risk? Financial risk?
  • All types of risk reduce company value. Liquidity and financial risk can be measured from financial statements. As they increase, company value declines.
  • A valuation technique is particularly important for small- and medium-sized companies. Large-company values are found in the security markets. Smaller companies do not have this luxury.

    The value of a company is determined ...