A top-down approach


Economic Analysis / Industry Analysis / Company Analysis

  • GDP
  • growth rates
  • Market size in terms of revenues
  • Trends
  • Biggest players
  • Competitive environment – buyers, suppliers, substitutes, porter 5-forces model that tells you competitive advantage of the company.

For a conglomerate like Google, you should know about each and every subdivisions, its products and services, current market trends and its competitors.



Fundamental Analysis

Perform the financial statement/fundamentals analysis of the historical balance sheet, cash flows and income statement to form an opinion on how the company did in the past by performing key ratio analysis on e.g. the last 3 years of financial statements.

Before you start ratio analysis, do the necessary adjustment for non-recurring items (one-time expenses or gains), capitalising operating leases, adjusting for LIFO reserve.


Earnings quality – normalising FS for fair comparison

  • Treat operating leases as capital/finance leases
  • Different depreciation methods
  • Different methods for accounting for inventory
  • Classification and recognition of income and expenses
  • Taking away non-sustainable nonrecurring items such as gains/losses from sales of fixed assets, changes in accounting estimates


As part of ratio analysis e.g. margins, do EV/Revenue or EBITDA, PE ratios so you can compare the company with others either a. publicly comparable company currently operating or b. recent M&A transactions that have taken place and the multiples they sold for with the value of our firm.

When using this ratio you compare with other companies within the sector and if it trades at a discount to competitors it may be undervalued), EV/EBITDA, P/BV etc.



Financial Modelling

Based on management’s apparent expectations, historical performances and industry competition, use the historical FS to project the financial statements like the BS, IS and CFs of the company in order to get cash flows and earnings forecast for the next 5 years. 





  • Use dividend valuation model for someone who is a minority shareholder and cannot influence future dividends of the firm.
  1. Project future years dividends using a growth rate applied to current FS
  2. You would discount future dividends using the WACC as your required rate of return
  3. You would have a terminal value at the end of e.g. Year 5
  • Could be a dividend that will grow into perpetuity which you would use the Gordon growth model       ⇒     Div at year 5(1+growth rate)/r-g
  • Could be a multiple for the industry to apply to your earnings at e.g. Year 5   e.g. Multiple x EBITDA

Whichever method you use you would discount the Terminal value to present value.

Combine all these and it will give you a value for your firm.


Instead of dividend going from one growth stage and immediately dropping to a long run growth rate, the H model does it linearly making transition more smooth.
A growth rate would be based on GDP inflation – usually not be more than say 3-4% for a mature company in a developed economy for cash flows to go into the future



Use FCF valuation for someone who is a majority and can influence dividend decisions

  1. Project future years FS using historical FS
  2. For each year calculate FCF for the next 5 years FCF = Net Income + Non cash charges + Interest(1-t) – FC Inv – WC Inv. Discount these cash flows by WACC
  3. For end of 5 years, come up with a terminal value and discount by WACC

Terminal value would be either;

  • Free cash flows into perpetuity using GGM :  Dividend at year 5(1+terminal growth rate)/r-g                  or
  • E.g. a multiple applied to e.g Year 5’s EBITDA based on comparable companies

      4. Take discounted FCFs for 5 years and discounted TV and add together = Enterprise Value

Enterprise value add cash, subtract Debt, MI & preferred stock = Equity Value. Equity Value/ weighted number of shares outstanding = Intrinsic value per share


FCFF (without discounting) – interest to bondholders(1-tax rate) + Net borrowing = FCFE .. which you would discount at cost of equity).
/weighted number of shares outstanding = Intrinsic value per share


If the Fair Price > Current Market Price, then the company shares are undervalued and should be recommended as a BUY.
If the Fair Price < Current Market Price, then the company stocks are overvalued and should be recommended as a SELL.


  • CF is the cash flow available after working capital and fixed capital have been taken care of, available to both debtholders and equity holders
  • Can still use if company doesn’t pay divs

WACC to use

(Cost of equity x % market value of equity) + (Cost of debt x 1-tax rate x % market value of debt)

Where cost of equity could come from CAPM = Risk-free rate + Beta for the stock(equity risk premium)



Multiples – using multiples that publicly comparable firms are trading at or recent mergers in the sector and how many times earnings was paid for them to apply a comparable multiple to the company’s current earnings to see what its fair value should be


EV = Market value of ordinary and preferred stock and MV of debt + Minority Interest – Cash

EBITDA = Gross Profit – Operating expenses i.e. R&D, selling and admin expenses, salaries

  • Useful because EBITDA is positive when EPS is not
  • Good when you want to compare companies and one has more capital intensive machinery or debt than the other


Market price per share/EPS

  • Not useful when earnings are negative
  • Earnings are susceptible to accounting manipulation



Market price per share/cash flow per share

  • Useful when earnings are negative
  • Cash harder to manipulate


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