9 - Company Valuation

Summary

In previous chapters, we introduced the fundamental principles behind understanding the value of financial investments, such as stocks, bonds, and options. However, many of these investments (such as shares of stock or bonds issued by a company or call options that allow the holder to purchase shares of a company’s stock) are based on specific companies. To fully understand such investments, it is necessary to better understand the companies that they are based on. In Chapter 8 we examined company financial statements as a first step toward analyzing companies in more detail. We now expand upon this and explore how the information from financial statements can be used to estimate the economic value of a company.

In this chapter we focus on further developing and applying our valuation tools to better understand company value. We begin by taking the perspective of an observer examining a company from the “outside,” that is, someone who cannot influence the way a company is run. In other words, given how a company is being managed by its current managers, what should its value be? Starting in the next chapter, we will consider the perspective of a manager from within a company, and determine how the actions of those running a company can affect its value.