Theoretically and practically, the value received for owning a business or a security is the dollar return amount received over time from your investment.
That return may come
- as a single payment at the end of the ownership period for selling the stock or business,
- as payments at regular intervals during ownership, or
- (often) as a combination of the two.
But growth and time value of money have a major impact on the final valuation of equity investment returns. In fact, intrinsic valuation is a lot about assessing the effects of future growth on future returns and then assigning a present value to those returns.
The following "how" questions can guide the appraisal of business returns.
How much?
How soon?
How long?
How consistent?
How valuable?
How much?
How many dollars of return will the business produce, either to distribute to shareholders or to invest productively in the business?
Key drivers are profitability and growth rates - and the collection of business factors that drive that profitability and growth.
How soon?
Big payoffs are nice, but if you have to wait 30 years for them, they aren't as valuable. Remember the time value of money.
If two companies produce the same return, but one does it sooner, that company has more value because those dollars can be reinvested elsewhere sooner for more return.
How long?
Although future returns have less value than current returns, they do have substantial value; and 20, 30, or 50 years of those returns can't be ignored, particularly in a profitable, growing business.
How consistent?
A company producing slow, steady growth and return is usually more valuable than one that's all over the map.
A greater variability, or uncertainty, around projected returns calls for more conservative growth and/or discounting assumptions.
How valuable?
Finally, after assessing potential returns (how much, how soon, how long, how consistent), you must assign a current value to those returns.
That value is driven by the value of the investment money as it may be used elsewhere. A return may look attractive - until the investor realizes that he or she can achieve the same return with a bond or a less risky investment.
Valuing the returns involves discounting (using a discount rate) to bring future returns back to fair current value. The discount rate is your personal cost of capital - in this case, the rate of return you expect to deploy capital here versus elsewhere.
Sooner isn't always better.
A business producing quick, short-term bucks may not be more valuable than one that produces slow, steady growth.
The quick-bucker may be cyclical and go through years of diminished or even negative returns. Even though the quick-bucker produces a lot of value in the first few years, that may not be better than sustained growth and value produced later on by the slower, steadier comapny.
The quick-bucker may be relying on a technology or some other competitive advantage that could dissipate or dissapper altogether. Likewise, a company with a long-term and sustainable advantage, sometimes known as a "moat" keeping competitors away, may beat a company with very high but only short-term returns.
Bottom line:
It's a combination of how much, how soon, how long, and how consistent.
The tortoise often beats the hare.
Present value calculator
http://www.moneychimp.com/calculator/present_value_calculator.htm
Inputs
Future Value: $
Years:
Discount Rate: %
Results
Present Value: $
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