How a company is valued
Every valuation is the same thought said differently: how much cash will this thing produce, and what is that cash worth today.
Why tomorrow's money is worth less
A thousand euros today is not the same as a thousand euros in ten years. Today you can invest it; then you no longer can. And inflation will have eaten part of it.
That's why every valuation discounts future profits at some rate. The higher the rate, the less money that is far away in time is worth today.
This is the single, sufficient reason why rising interest rates push share prices down, without anything changing at the companies themselves.
Three routes to the same question
The discounted cash flow method models the future cash directly. It is the most honest and, at the same time, the most sensitive to assumptions — change the growth rate by one percent and the result shifts visibly.
The comparables method looks at what the market pays for similar companies. It is quicker, but it only tells you whether something is cheap compared with the others, not whether it is cheap in itself.
The asset method asks what you would get if you sold everything. It makes sense for banks and real-estate companies, and almost none for a software company.
What to do with the number you get
None of these methods gives a single answer. They give a range, and the width of that range is itself the information.
If you have to assume 15% growth for twenty years for today's price to make sense, you haven't found a cheap company — you've found what the market has to believe.
Valuation is more useful as a check on expectations than as a forecast. It tells you what you are buying, not what you will earn.
Which method for which company
| Method | Works well for | The weakness |
|---|---|---|
| Discounted cash flow | Steady profits | Very sensitive to assumptions |
| Comparables | Mature sectors | The whole sector may be overvalued |
| Asset value | Banks, real estate | Ignores the brand and growth |
Key terms in this lesson
- Discount rate
- How much less future money is worth today. It climbs along with interest rates and risk.
- Discounted cash flow
- A valuation that adds up a company's future cash, each amount discounted for time.
- Intrinsic value
- What a business is worth based on the cash it produces, regardless of the market price.
Quick check
Why do rising interest rates push share prices down even when the companies themselves haven't changed at all?
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