Hi everyone. Throughout the course, we've obtained an understanding of financial statements in what's disclosed in SEC filings. We put this understanding to work, to calculate various financial ratios that allowed us to identify trends, and risk, and opportunities. We went beyond the financials, analyze the company's strategies and initiatives, and assess competitive dynamics. Next, we put these insights together to develop a future outlook or forecast for the company. Now it's time to pull it all together and utilize our forecast as an input into a valuation model that allows us to determine a company's intrinsic equity value. Or said another way, a model that allow us to tell what a company's stock should trade at based upon the fundamentals of their business. Throughout this video, we'll discuss the uses of valuation techniques and the different approaches to calculate a company's valuation. Before jumping into the valuation models, let's begin by discussing why calculating valuations are important and the many uses of determining a valuation. Valuations are used by companies everyday. Key business decisions, such as whether to invest in projects or initiatives are based upon the value they generate for a firm. Decisions such as whether a manufacturing plant or division should be expanded or closed. Whether additional spending and capital equipment generates a sufficient return. Or whether additional investments in advertising or research and development drives sufficient growth, are all based upon valuation models. In addition, companies run valuation models, is they evaluate mergers and acquisitions, expansion and divestiture decisions. Specifically related to equity markets, valuation models are critically important and widely used by analysts and shareholders. Valuation models are used to help set the opening share price in an IPO. They help determine if an investor should buy, sell, or hold a company stock, or determining the price of other financial instruments. There are several valuation models used extensively by finance professionals, investors, and analysts. Simply, but there's not a one size fits all approach. In order to determine which one is right for your company, there are several factors that need to be considered, such as, what are the critical assumptions needed for the valuation model in identifying if this data is available for your company? Which model is most commonly used in your industry or sector, and the lifecycle of your company? For example, many mature businesses utilize price to earnings or enterprise value to EBITDA models due to their simplicity and stability of trends within their financial data. Well, many startup companies who have negative equity balances, operated net loss, or have negative cash flow would often use evaluation model based upon a multiple of sales. On the other hand, a more detailed or advanced valuation model, such as the discounted cash flow model, is often used to perform a deeper level of analysis required to evaluate the return on a project or an investment. Again, there's not a one size fits all approach. You need to evaluate the facts and circumstances of each case to determine which model is appropriate for your purposes. There are two types of valuation models, simple or basic and detailed or advanced. Much of our focus will be on the simple or basic models. These are the valuation models that calculate averages or multiples of peer companies and applies it to the target company to calculate their estimated valuation. Common or widely used simple or basic valuation models include Priced to Earnings or PE, Price to Book or PB, Price to Sales or PS, and Enterprise Value to EBITDA Multiple. Detailed or advanced valuation models involves a more extensive calculation in order to determine a company's estimated valuation, is typically involve a 3-5 year forecast, discounted back to present values, and valuations are often based upon projections exceeding a required rate of return. Common or widely used detailed or advanced valuation models include the discounted cash flow model, residual income model, or the residual operating income model.
