Absolute Valuation Formula

What is an Absolute Valuation Formula?

The term “absolute valuation” refers to the method of business valuation that utilizes DCF analysisDCF AnalysisDiscounted cash flow analysis is a method of analyzing the present value of a company, investment, or cash flow by adjusting future cash flows to the time value of money. This analysis assesses the present fair value of assets, projects, or companies by taking into account many factors such as inflation, risk, and cost of capital, as well as analyzing the company's future performance.read more to determine the fair value of the firm. This method helps in the determination of a company’s financial worth on the basis of its projected cash flows. Basically, the formula for discounted cash flow is calculated by adding up the cash flow in each period that is divided by one plus the discount rate, which is again raised to the power of the number of periods.

Absolute Valuation Formula

This equation and the stock is represented as follows –

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For eg:
Source: Absolute Valuation Formula (wallstreetmojo.com)

#1 –Absolute Valuation Formula of Business

Mathematically, the Absolute Valuation Equation can be represented as,

where,

• CF_i = Cash flow in the i^th year
• n = Last year of the projection
• r = Discount rate

#2 – Absolute Valuation Formula of Stock

Finally, the absolute value of a stock equation is calculated by dividing the absolute value of the business by the number of outstanding shares of the companyOutstanding Shares Of The CompanyOutstanding shares are the stocks available with the company's shareholders at a given point of time after excluding the shares that the entity had repurchased. It is shown as a part of the owner's equity in the liability side of the company's balance sheet.read more in the market, and the absolute value of a stock is represented as,

Absolute value _Stock = Absolute value _Business / Number of outstanding shares

Explanation of the Absolute Valuation Formula

Example of Absolute Valuation Formula (with Excel Template)

Let us take an example of a company ABC Ltd and a particular analyst is interested in predicting the fair value of the company based on the available financial informationFinancial InformationFinancial Information refers to the summarized data of monetary transactions that is helpful to investors in understanding company’s profitability, their assets, and growth prospects. Financial Data about individuals like past Months Bank Statement, Tax return receipts helps banks to understand customer’s credit quality, repayment capacity etc.read more. The investor’s expected required rate of return in the market is 6%. On the other hand, the company has projected that the free cash flow of the company will grow at 7%. Determine the absolute value of the stock on the basis of the following financial estimates for CY19:

So, from the above-given data, we will first calculate the CF for CY19.

CF _CY19 = NOPAT + Depreciation & Amortisation expense – Increase in Working Capital – Capital Expenditure during the year – Debt Repayment + Fresh Debt raised during the year

• $150.00 Mn + $18.00 Mn – $17.00 Mn – $200.00 Mn – $35.00 Mn + $150.00 Mn
• $66.00 Mn

Now, using this CF of CY19 and CF growth rate, we will calculate the Projected CF for CY20 TO CY23.

Projected CF of CY20

• Projected CF _CY20 = $66.00 Mn * (1 + 7%) = $70.62 Mn

Projected CF of CY21

• Projected CF _CY21 = $66.00 Mn * (1 + 7%)² = $75.56 Mn

Projected CF of CY22

Projected CF _CY22 = $66.00 Mn * (1 + 7%)³ = $80.85 Mn

Projected CF of CY23

• Projected CF _CY23 = $66.00 Mn * (1 + 7%)⁴ = $86.51 Mn

Now we will calculate the Terminal ValueCalculate The Terminal ValueThe terminal value formula helps in estimating the value of a business beyond the explicit forecast period. It includes the value of all cash flows, regardless of duration, and is an important component of the discounted cash flow model (DCF).read more.

• Terminal value   = CF _CY23 * (1 / Required rate of returnRequired Rate Of ReturnRequired Rate of Return (RRR), also known as Hurdle Rate, is the minimum capital amount or return that an investor expects to receive from an investment. It is determined by, Required Rate of Return = (Expected Dividend Payment/Existing Stock Price) + Dividend Growth Rateread more)
• $86.51 Mn * (1 / 6%)
• $1,441.88 Mn

Therefore, the calculation of absolute valuation will be as follows –

Calculation of Absolute valuation of Company

• Absolute Value = $1,394.70 Mn

Now, we will calculate the fair value of the stock, which is as follows –

• The absolute valuation of the stock = Absolute valuation of company / Number of outstanding shares
•  $1,394.70 Mn / 60,000,000

Calculation of Absolute valuation of Stock

• $23.25

Relevance and Use

From the perspective of a value investor, it is very important to understand the concept of an absolute valuation equation because it is used to check whether a stock is over or undervalued. However, it is very challenging to forecast the cash flows with certainty, the growth rate, and to assess how long the cash flows will continue to grow in the future. Therefore, this method should be used but with a pinch of salt.

Recommended Articles

This has been a guide to Absolute Valuation Formula. Here we discuss how to calculate Absolute valuation and Stock using practical examples along with a downloadable excel template. You may learn more about Valuations from the following articles –

• Value Formula in Excel
• Top Valuation Methods
• DCF
• Post Money Valuations