What’s a company worth?
Key to successful investing is not paying more for a stock than it’s worth. We need to compute the intrinsic value of any asset and compare that number to the market’s valuation before we buy something. A firm may be a great place to work, have a wonderful management team, and have strong financial performance but be priced so high that the stock is unlikely to perform well in your portfolio.
Conversely, a company may be performing poorly, but be priced below its intrinsic value. There’s a big difference between a good company and a good investment. Understanding the difference is absolutely essential. But how do we calculate intrinsic value?
There are two steps to estimating what a stock is worth. The first is to evaluate the company, the second is the measure the stock price. When it comes to understanding a firm, you want to get a sense of its business, its products, and its strategy. Does it have a low-cost strategy or a differentiation approach. Firms that rely on low costs need to keep tight control of their processes. Differentiators have to have a creative flair and strong capabilities in basic research. One strategy focusses on processes, the other depends on people.
Business Process Management. Source: Wikipedia
These dynamics hold true whether the company is an established tech giant or a consumer product start-up. Companies either compete on price or on innovation. The nature of the industry will determine how robust demand will be for their products during economic booms and busts, but the internal dynamics of the company—its competitive strategy, and well it executes this plan—establish some of the more subtle inputs to any financial valuation model.
Companies are more than just their accounting ledger entries. If that’s all there were to building and managing a business, CEOs would all be accountants. Before we start to crunch the numbers, we need to know what’s going on underneath the numbers.
Douglas R. Tengdin, CFA
Chief Investment Officer