Valuation, Estimates and Investment Recommendations
Valuation
Valuation consistency
Valuation methods include DCF, trading comparables, precedent transactions, dividend discount, residual income, and sum-of-the-parts. The central discipline is matching the cash flow to the discount rate and the value to the capital structure. Use unlevered free cash flow with WACC to get enterprise value; subtract net debt and preferred stock, then divide by diluted shares for equity value per share. Use levered cash flow with cost of equity for direct equity value. Multiples: EV/EBITDA, EV/EBIT, and EV/Sales are enterprise-value multiples; P/E, P/B, and P/FCF are equity multiples. Never divide enterprise value by net income or market capitalization by EBITDA.
Traps: terminal growth greater than or equal to WACC; a peer set with different growth, margin, or leverage; applying a current multiple to peak cyclical earnings without normalization; forgetting minority interest, pension deficits, or operating leases in net debt; using basic rather than diluted shares; mixing nominal cash flows with real discount rates. Sensitivity tables should show WACC and terminal growth.
Worked example / rule of thumb: Gordon terminal value = FCF(next year) / (WACC - g). If FCF = $100, WACC = 9%, and g = 3%, TV = 100 / 0.06 = $1,667. If g = 9%, the formula breaks. Keep g below WACC and below long-run economic growth.
Estimates and Investment Recommendations
Building and defending estimates
Estimates should be driver-based: volume x price, segment revenue, gross margin, operating expenses, tax, and share count. Show the bridge from company guidance or the prior model to your numbers. Distinguish consensus, company guidance, and your own estimate. Update for new filings, guidance, macro data, and M&A. Recommendations should specify time horizon, price target, methodology, catalysts, and risks; bull/base/bear cases improve rigor.
Traps: stale EPS after a guidance cut; double-counting synergies; ignoring share issuance or buybacks; using a price target that is not generated by the model; a "Buy" rating with downside risk not disclosed; changing estimates without documenting why; anchoring to consensus. Also check that quarterly estimates sum to annual and that cash flow ties to EPS.
Worked example / rule of thumb: If revenue = 1,000 units x $50 = $50,000, gross margin 40% = $20,000, operating expenses $12,000, EBIT $8,000, tax 25% = $2,000, net income $6,000, diluted shares 3,000, EPS = $2.00. Rule: change one driver at a time and trace the EPS impact; if the rating changes, the target and thesis must change too.