# Stock valuation - Real world application

Hi, I am trying to value a stock using the concepts i have learn t in CFA level 1. Below is the scenario. Google (goog) B/S - Assets = 40bn Liabilities = 4bn Equity = 36bn (Retained Earnings - 20bn) I/S - EPS = 20.11 (diluted) remaining same forever (perpetuity) Total no of shares = 0.32bn No dividends, assuming no growth rate. I am trying to find the current value of the stock, i am trying to be as conservative as possible i am taking a ROR of 5.25% pa (10yr note) + 2% current US inflation (assumption) Here is my calculation: Current value as per the book + future earning (36/0.32) + (20.11/0.0725) = 112.5 + 277.3 = 389.87 is this reasonable for stock valuation? The intention of this exercise is to apply my knowledge directly to a real world scenario any healthy comments would be greatly appreciated. Thanks

1. It might be better to discount cash flows to equity rather than EPS (eliminates accounting distortions). refer to the cash flow statement 2. 7.25% isnt a conservative discount rate for equities (tech stocks at that!). you might want to apply CAPM. an indicative 12%-15% range might be more appropriate. of course, you also need to adjust for leverage / earnings growth rate assumptions 3. the way you have computed it double counts valuation i.e current book value is part of total capital employed in the company and its that capital which generates future earnings. the purpose of your valuation is to determine a fair value for that capital (enterprise value / equity value). look at it this way, if a machine costs \$1,000 and generates \$100 in annual profits, discounted at 10% the fair value of that machine is not \$1000 + (\$100/0.1) = \$2000. the fair value (what you would pay for that machine) is \$1000 because you want a 10% ROI. 4. double check your valuation estimate with other methods (multiples, analyst consensus etc) to see if it makes sense 5. refer to a good valuation book (e.g. mckinsey on valuation) for more in depth study

Thanks oz001 that was really help full. That clears up some questions i had. One important things can i use book value + dividends (as cash flows) to determine the stock?

i dont think so. thats combining two different valuation methodologies. u could use either a book value multiple or discounted cash flow / dividend discount model.

The answers to all these questions is pretty much no. It’s like learning Black scholes for the first time and deciding that you can make your computer beat the options market. Doing this kind of analysis is good practice for CFA exams, but usually the bigger the company, the more difficult it is to get thing to tie out in neat CFA ways (I haven’t looked at GOOG financials in probably ever so I don’t know about them). There are all kinds of good lessons to be learned from FSA but the big ones are stuff like: a) growth rates matter huge and they are unpredictable (at least to me). b) there are lots of shenanigans in books that give you some idea of risk in investing in the company - off-balance sheet stuff, goodwill, treasury stock holdings, and just about anything you look at and say “What the heck is that?” c) Debt is leverage for better or worse d) Many of the items on the financials require examination - e.g. inventory for a silver producer is much more easily valued than inventory for Barnes and Noble. e) You can use financials to do stuff like assess cash takeout risk on converts much more easily than you can use it to decide whether a stock is fairly priced. So in general, you are being taught stuff that doesn’t work for what the tell you it works for. But learning it is still valuable. BTW - Imagine if Yahoo gets taken out by Blackstone or someone while Google is still investing money in driverless cars and windfarms. It will be the most differently managed companies to ever be the two market leaders in the history of the earth.