ValuePro Frequently Asked Questions

Why buy the ValuePro Program when the Online Valuation Service is Free?

The Online Valuation Service is a great free service and provides a good starting point for a valuation. However, it makes simplistic assumption in the lookup process and the inputs for the service only represent a snapshot of the company's prospects. The ValuePro software is more detailed and thorough, it allows you to change inputs and assumptions over time, has a weighted average cost of capital screen and custom valuation screens, allows you to print out five different screens associated with a valuation, and allows you to save and retrieve valuations.

Using the software, you can value any stock, not just the over 5000 stocks that we follow in our database. The ValuePro software also allows you to instantaneously download the initial data for a valuation (for the 5000 stocks that we do follow) from the web site. And at $44.95, we think that it's a bargain.

Please read the link on our web site, Guide to the ValuePro Software, for an in depth description of the Program.

Questions about the Online Valuation Service Database. purchases a pre-ordained set of financial data from an information service provider. We have no say as to which companies and stocks are included. The data is updated periodically, usually on a weekly basis. We can't add stocks to the database.

What is Intrinsic Value and why is it so high or low for a valuation?

We use the discounted cash flow to the firm (DCFF) method of valuation when we value a stock. The intrinsic value is the present value of the future expected cash flows related to a share of stock. If all of the underlying assumptions are correct, the intrinsic value should be what the stock should sell for today.

The two inputs that have the greatest effect on intrinsic value are the growth rate of the company's sales and cash flows, and the company's net operating profit margin (NOPM). For growth rates, we use analyst expectations. The lookup process of the online valuation service calculates NOPMs, Investment Rate, Depreciation Rate, and Working Capital Rate based on historical data, comprised of the most recent balance sheet, cash flow statement and income statement data for the company. This data may be higher or lower that expected future levels for the company. Stock values are based on expectations of the future, not so much as what happened in the past. So the company's intrinsic value may be too high or too low due to a negative NOPM, or artificially high analyst expectation of a company's growth prospects.

Does the DCF method of valuation work well for all stocks?

No. It works well for perhaps 90% to 95% of all companies, but often does not work well for some highly levered companies like financial stocks (brokers, banks and insurers) and REITs.

How do you calculate a company's weighted average cost of capital (WACC)?

Go to our link, Learn the ValuePro Approach, and click on our sub-link, Calculating the WACC.

What is the Equity Risk Premium how do you calculate the cost of equity?

The annual rate of return that an investor expects to earn when investing in shares of a company is known as the cost of common equity.  That return is composed of the dividends paid on the shares and any increase (or decrease) in the market value of the shares. For example, if an investor expects a 10% return from McDonald's stock and she buys a share at $67.25, her expectation is to receive $6.72 during the year through a combination of dividends (currently $.34 per share during 1998) and the appreciation of the stock price (presumed to be $6.38 to give her the 10% expected return totaling $6.72) during the year.

Let's now take a look at what rate of return, in general, an investor should expect from a stock. The return expected of any risky common stock should be composed of at least three different return components: (1) a return commensurate with a risk-free security (Rf); (2) a return that incorporates the market risk associated with common stocks as a whole (Rm); and (3) a return that incorporates the business and financial risks specific to the stock of the company itself, known as the company's beta.

The first measure of return (Rf) relates to what market rate of return is currently available from a risk-free security, like the yield associated with a long-term Treasury Bond. So if the yield on Treasury Bonds is 5%, an investor should expect a return greater than 5% for a common stock.

The second measure of return (Rm) relates to what market returns are currently available from and what risks are associated with stocks in general. There is a general risk premium (the equity risk premium) associated with the stock market as a whole. That risk premium should be priced into any equity investment.  For example, if you expect to earn 8% on average (from a diversified portfolio) in the stock market and the risk-free rate is 5%, the Equity Risk Premium (Rerp) would be (Rerp) = (8% - 5%)= 3%.

   Equity Risk Premium(Rerp) = Exp. Return on Market(Rm) - Risk Free Rate(Rf)

The third measure of return versus risk (beta) should be related to the specific stock being purchased-how risky is the type of business the firm does and how risky is the financial structure or leverage of the firm.  Beta measures the risk of the company relative to the risk of the stock market in general. With greater risk, as measured by a larger variability of returns (business or operating risk), the company's should have a larger beta.  And with greater leverage (higher debt to value ratio) increasing financial risk, the company's stock should also have a larger beta.  And with a larger beta, an investor should expect a greater return.  The beta of an average risk firm in the stock market is 1.00. 

The financial risk model that uses beta as its sole measure of risk ( a single factor model) is called the Capital Asset Pricing Model (CAPM) and is used by many market analysts in their valuation process. The relationship between risk and return that comes out of that model and the one that is incorporated into our FCFF analysis and spreadsheet software is:

                           Exp.(Rs) = (Rf) + beta(Rerp)

which in English translates to "The expected return on a stock (e.g. McDonald's) is equal to the risk free rate (e.g. 5%) plus the specific stock's beta (e.g. 0.97) times the equity risk premium (e.g. 3.0%)."  In numbers it looks like this: Expected Return on McDonald's Stock = 5% + 0.97(3.0%) = 7.91%