Cash Flow and Analysis

Valuation Methods When it comes to the valuation of equities, there are three different methods that are commonly used. These three methods are the dividends valuation method, the free cash-flow method and the market-based method. As one might expect, there are pros and cons to each approach. As such, a proper compare and contrast of what is better in what ways and what is potentially inferior in other ways can and should be ventured into.

Of course, there would be advantages and disadvantages to all three methods and this would thus lead to one method being favored in a given situation, for whatever reason. While the perceived outcomes and such would be different for each method, the proper method of valuation should be chosen based on the situation and the perspective/needs of the company or person doing the evaluating.

Analysis When it comes to the free cash flow method, this involves a simple analysis that is used to predict and project what is likely to happen in the near future. Indeed, ascertaining whether a company will soar or fall in terms of value is the way in which people make money. People that guess right are rewarded for their investment while people that guess wrong have to go back to the drawing board. One of the main methods is known as the operating free cash flow method.

This is based on the cash that is generated by operations. This cash flow is then attributed to all of the relevant providers of capital when it comes to the firm's overall capital structure. This would and should include both funders and debt providers to the same situation. Generally speaking, the operating free cash flow is figured by taking the earnings before interest and taxes and then adjusting for the tax rate. Depreciation is added and capital expenditure is subtracted from this figure.

There is also the subtraction of working capital change and changes in other assets. The figure that is then garnered is the free cash flow for a firm. This, in combination with the growth rate, is seen as one of the primary ways to see what direction a firm is going in. This can be a good indication, so this would be an advantage. The downside is that there are other metrics and details that could and should be taken seriously when it comes to equity valuation (Cherewyk, 2011).

When it comes to the dividend model for valuation, this is otherwise known as the Gordon Growth Model. This model basically takes the value of the dividends in the future that are then discounted back to their present value. It values a stock based on the net present value (NPV) when it comes to the dividends that are expected in the future.

A pro of this method is that it is the most commonly used model to calculate the share price and thus is commonly the easiest to understand for the financial community that would be using or observing it. However, there are a number of cons including not taking non-dividend factors seriously enough. Example would include brand loyalty and customer retention. Also, dividends are not assured even if they are expected (Tarver, 2015). As far as the market business valuation method goes, it is empirical and/or heuristic to use this method.

Thus, it is commonly accepted. However, any comparison made need to be relevant and realistic for these valuation methods to be taken seriously (Valuadder, 2016). Conclusion When it comes to the valuation of equities and the methods used, it is imperative that the proper method.