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Principles of finance ah la shmoop other evaluation formats All

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right well what do you do if you have no

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earnings argue worth nothing Not that i'm broke or anything

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Just asking you know for a friend Like what if

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you were building out a next generation tele communications platform

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which had ten times better connectivity and one hundred times

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the speed Maybe you have eight billion dollars of revenue

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this year and fifteen billion dollars of costs half of

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which is not a cash cost It's just appreciation over

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the wires you put in the ground So let's make

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up some numbers here and say you have a billion

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dollars in cash losses Are you worth zero No not

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by a long shot Instead to calculate what you're worth

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lazy wall streeters quote impute a profit margin unquote and

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then take a multiple of that margin That is the

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deposit well hook a fall I think this company is

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a thirty percent operating margin business It will always have

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leverage like the cable and phone businesses and at maturity

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it'll have twenty percent net profit margins well at a

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twenty percent margin on projected revenues three years from now

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Of twenty billion dollars Well that means the company would

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then have four billion dollars in earnings at that point

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was still very high growth rates of twenty five percent

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revenue growth Well it might trade it twenty five times

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that earnings number ignoring dead and or cash on the

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balance sheet for now So at twenty five times the

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earnings of four billion dollars will not get you one

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hundred billion dollars valuation Well the company today is not

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worth that much money There is risk ahead and time

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So again being lazy wall streeters we just cut the

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number in half and say yeah it's worth fifty billion

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today And if i doubled my money in three years

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with this stock well that'd be a pretty good score

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yet you khun by the company today for a market

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calf of forty billion dollars that's its market capitalization So

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at forty billion dollars today with a tie target of

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one hundred fifty billion three years from now Isn't that

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a strong by and when you present the investment opportunity

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to your partner's you'll describe it in part as a

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quote multiple of sales unquote story at five times sales

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Of eight billion dollars this year we'll often multiple of

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sales stories which then turn into earnings stories Do very

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well if and only if they execute on the revenue

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growth and the margin structure they said they would if

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you configure out how to predict these transitions Well that's

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the buy side of wall street and enormous wealth waits

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for you moving on evey enterprise value versus even dog

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earnings before interest taxes depreciation amortization Got it There's a

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smack down here it's a common evaluation metric in companies

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with a whole lot of debt and who are depreciating

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a whole lot of capital expenditures Well often these companies

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don't have real gap earnings So another method has to

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be worked out to evaluate the company's self worth you

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know other than ours of freudian therapy All right first

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recall what enterprises and no not the spaceship nor the

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car rental company Let's Start with something super simple of

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your home You just bought it for a million dollars

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putting two hundred grand down and taking out a mortgage

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for eight hundred thousand dollars Good for you Well the

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equity or equity capitalization or equity value you have in

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your home at this point is two hundred grand and

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the homes enterprise value is a million dollars for cos

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it works kind of the same way Let's say human

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catapults inc has even of forty million box and one

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hundred sixty million dollars of debt Well its growth rate

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and industry trends suggest that it should trade it about

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end times Even so ten times even i would give

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us four hundred million dollars of gross or enterprise notional

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value for the company And when the humans actually smacking

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toe walls at fifty knots well the naming run really

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fits But there was one hundred sixty million dollars of

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debt in this company as well which has to be

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subtracted from the gross or enterprise value Well if we

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subtract one hundred sixty million for four hundred million to

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get two hundred forty million of equity value well then

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that's the market value probably And we'd say that this

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firm is lev urd or leveraged for toe one debt

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Teo even done We then ask ourselves how does this

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compare to human slingshots ink and to the humoring inc

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As weapons of miss destruction slingshots traded a lower multiple

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Because well misfires air costly But human arang trades at

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a premium of twelve times ebitda because of the nature

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of its physics in the form of reusable humans when

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the shot is a miss well this would be the

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comparable company multiple And in this case human catapults trade

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expectedly at the midpoint of the range of comparable companies

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All right moving on The last valuation metric is discounted

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cash flow analysis which is the heavy valuation machinery The

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wall street pros generally used a zey truth test This

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is such a big and gnarly area that well we

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had to go borrow money to go higher hollywood talent

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to make it work So in this flick you just

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get the appetite wetter As we've said nine thousand three

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hundred seventy two times already a dollar today is worth

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more than a dollar tomorrow This is the heart and

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soul of discounted cash flow analysis So let's take a

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look Company acts will produce net after everything cash of

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one hundred million box in your one two hundred million

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in year two to fifteen year three five hundred million

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year four eight hundred million year five All right this

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would be called shockingly a five year discounted cash flow

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analysis Clever your next step is to figure out the

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discount rates well the risk free rate is usually whatever

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us government bond paper trades for in the analogous time

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period and that is you find a ten year t

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bill that's like halfway through its lifespan and figure out

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what that rates paying in let's say three percent these

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days So that's the risk free rate Well the risk

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premium is the extra hurdle rate of interest you'll charge

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in risk to the deal Instead of producing millions you

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know one hundred million two hundred and fifty million bubble

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block they produce actually one hundred million one hundred million

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hundred million fifty million got it so the company might

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stink but it also might do a ton better than

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projections The projections should generally be in the you know

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fifty fifty over under zone e most likely case So

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let's say the premium on this set of cash flows

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is eight percent to produce a total of eleven percent

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right Three percent risk free plus eight percent that we're

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going to tack on for risk here You then just

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set up the equation such that the first five years

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show cash produced And then at the end of those

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five years the company is sold or goes public or

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gets liquid in whatever form and let's say it sells

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for eight billion dollars at the end Teo google the

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tricky part in this set lies in the power it

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oration of the equation It would look something like this

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You do not need to do the math Just look

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at it it's Not important Not at this stage All

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you have to do is think Yes we ask a

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lot Note that the denominator of one point one one

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is iterated aton more in the out Years versus year

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one and one point one one two the fifth powers

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about one point seven So think about that conceptually in

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year five you're dividing those huge numbers by a pretty

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big number The notional eight hundred million dollars in profits

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at that point on a discounted basis is eight hundred

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guided by one point seven and we're about four hundred

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seventy million Almost half that is its present value is

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just a bit more than half its terminal value and

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we'll cover so much discounted cash flow in another video

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It'll make you sick So if this is all over 00:07:33.274 --> [endTime] confusing now just wait The madness has just begun

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