Analysis, Modeling and Valuation
From statements to a model
Begin with common-size analysis (each line as a percentage of revenue or assets) and a DuPont decomposition: ROE = net margin × asset turnover × leverage. That reveals whether returns come from pricing, efficiency, or balance sheet. Then test quality of earnings: accruals versus cash flow, cash conversion (CFO ÷ net income), capex versus D&A, days sales outstanding and inventory trends, and the size of the gap between reported and adjusted figures.
The three-statement link
Forecast revenue by driver (volume × price, units × ARPU, backlog conversion), then flow through to margins, working capital as a percentage of sales, capex as a percentage of sales, and a depreciation roll-forward. Interest on average debt creates circularity - accept iteration or use beginning balances and disclose the choice.
Valuation mechanics
For a DCF: unlevered free cash flow, WACC from CAPM with a relevered beta (Hamada), terminal growth below long-run nominal GDP, and a mid-year convention. For multiples, keep numerator and denominator consistent - enterprise value pairs with EBITDA, EBIT, and revenue; equity value pairs with net income, EPS, and book value. Build EV as diluted market cap (treasury-stock method) + debt + preferred + minority interest − cash.
Traps
- Mixing LTM and forward multiples across peers with different fiscal year ends (calendarize first).
- Using book value of debt in WACC without flagging the approximation.
- Ignoring option, warrant, and convertible dilution in share count.
- Letting terminal value exceed roughly 75% of total EV without justification.
Worked example
Market cap $5,000, debt $1,200, preferred $200, minority interest $100, cash $300 → EV = 5,000 + 1,200 + 200 + 100 − 300 = $6,200. At EBITDA of $620, EV/EBITDA = 10.0x.