Valuation Techniques: Discounted Cash Flow, Earnings Quality, Measures of Value Added, and Real Options

FOREWORD

Few skills are more essential to a security analyst than the ability to evaluate a company’s performance in a concise and compelling manner. Given the importance that firm valuation plays in financial markets, the wealth of research literature on the topic (including contributions from such giants in the investment management profession as Gordon, Graham, Dodd, Modigliani, Miller, and Tobin) is not surprising. In spite of all the intellectual firepower that has been aimed at the issue, however, performance evaluation can hardly be considered a permanently solved puzzle. Indeed, recent years have witnessed the ascent of a sometimes confusing array of terms—EVA®, MVA™, CFROI—representing state-of-the-art statistical measures intended to take the place in analysts’ hearts and minds of the traditional market-based metrics, such as return on assets (ROA) and return on equity (ROE).1 Although it is widely acknowledged that these new methods are often useful, it is not clearly understood where they fit in the analyst’s toolkit.

In this chapter, Pamela Peterson and David Peterson help make sense of these contemporary developments and provide a context in which to compare the new with the old. The authors also do a great job of dispelling some current myths about the latest generation of evaluation techniques. For example, one interesting aspect of these new performance tools is that they are not all that new. Economic value added has its origins in the notion of economic profit, ...