| When investing, the right place to pay for a stock is | | | | and will also depend on the competency of the |
| always vital and also very subjective due to the lack | | | | analysts projecting the future. |
| of information as well as difficulty in predicting the | | | | Among the above-mentioned future benefits, ODCF |
| future. | | | | is the most important cash flow measurement to |
| Basically, there are three main approaches in deriving | | | | investors. ODCF is commonly defined as operating |
| a company's value, which are income, market and | | | | earnings before depreciation, interest, taxes one |
| asset. Price-to-earnings ratio (PER), dividend yield | | | | owner's compensation. All compensation and |
| (DY) and price-to-earnings ratio (P/BV) are | | | | operating expenses are adjusted to market. |
| categorized under the market approach, where the | | | | This method provides a more realistic picture of the |
| key principles behind these methods are dependent | | | | amount of money that will be available to pay to the |
| on their relative multiple against the market price. | | | | owners of the business as a return on their |
| For the asset approach, the valuation will be based | | | | investment. This method is usually used to find the |
| on the fair market value of the company's assets. Of | | | | value of a 100% or majority controlling interest in the |
| the three approaches, income is the primary one | | | | company. |
| used to value operating companies. It's based on the | | | | Usually, the main reason of most companies is to |
| principle that the company's value will be derived | | | | reduce tax payment. They will try their best to |
| mainly from the sum of the future benefits expected | | | | include a lot of expenses or have high salaries and |
| to be produced for the owner of the interest. | | | | director remunerations in order to reduce profit so |
| A rate of return or discount rate will then be used to | | | | that tax payments will be lower. Thus, there is a big |
| discount all future benefits to the present value. It's | | | | difference between cash flow paid to the owner and |
| used to determine the fair market value of the | | | | cash flow distributed as dividends to other minority |
| normalized net operating assets. | | | | shareholders. |
| There are two main components in the income | | | | As a result, ODCF is superior to income-related future |
| approach, which are the appropriate future benefits | | | | benefits like net income, pre-tax income, free cash |
| and discount rates. The future benefits can be in any | | | | flow, EBIT and EBITDA, as the latter are unable to |
| of the following forms like owner's discretionary cash | | | | provide the real picture of cash flow to a company's |
| flow (ODCF), net income after tax, net income | | | | owner. This is why some companies' owners are |
| before tax, free cash flow, earnings before interest | | | | willing to be involved in loss making companies for |
| and tax (EBIT) and earnings before interest, taxes, | | | | years. |
| depreciation and amortization (EBITDA). For | | | | Thus, the ordinary investors who have no control in |
| investors, the discount rates are referred to as the | | | | the company's operation need to be extra careful in |
| required rates of return. | | | | picking the right company in which to invest. They |
| Most of the time, however, analysts have difficulty in | | | | need to select honest and competent owners who |
| deriving the above two components. If a business is | | | | will always try their best to increase shareholders' |
| complex, predicting its future benefits and discount | | | | value. |
| rates with a high degree of certainty will be difficult | | | | |