SummaryBusiness AssessmentFinancial Shape AssessmentA-List RatingsValuation Appraisal
Sell-side ResearchSponsored ResearchBenefits of A-List
Why Equity?Why A-List?

Research Process

Stage 4: Valuation Appraisal

We make an appraisal of fair valuation for A-List and B-Team companies only. Core to our approach is a willingness to pay up sensibly for quality rather than having an obsession with a share being seemingly “cheap” at the time of purchase.

We construct detailed financial models and forecasts. The intention here is not simply to add yet another short-term EPS forecast to the mass already out there. Rather, we see construction of a model as a discipline to ensure that we really understand what drives the business. Our forecasts look 3 years ahead and include, in addition to the usual metrics and ratios, a careful appraisal of return on equity, broken down into its constituent parts. 

For a company to have reached our valuation stage, we have already established that it has outstanding economic, quality of business and financial attributes. This process aims to have removed the principal danger of investing, which is that of investing in a weak or flawed business. With the luxury of a long investment time scale, valuation becomes of secondary importance, albeit an importance that is real.

A great business should be able to build its owners’ wealth by perhaps a factor of ten over a timeframe of maybe ten or fifteen years. That’s enough to drive a share price from 100p to 1,000p. But the key driver of returns on this scale will be the quality of the business, and not its valuation at the starting gun relative to peer companies or ‘the market.’ If 1,000p is the finishing line, a willingness to pay 120p rather than 100p still gets us on board a superior business that delivers the goods. Equally, our valuation appraisal recognises that, while paying 120p may give the same ball-park investment return as paying 100p, paying 500p does not.

coin counting

Sell-side research tends to overlook this key fact. It typically provides a single point target price that is arrived at by applying a multiple to this or next year’s projected earnings. The research may advise you to avoid, sell or switch out of a good company, based only on near-term earnings forecasts. The assumption is made that all companies in a sector should trade on the same earnings multiple, overlooking the unique qualities or potential of individual businesses. While such research may generate trading volumes and commission income, it can do a disservice to investors, causing them to miss out on a good quality share or to back an inferior and underperforming company just because it is cheap.

We always look at valuation measures beyond the price earnings ratio. That is because the PER is perhaps the only measure that other investors are looking at and because it suffers from the vagaries of profit recognition and the limitation of being based on a single year’s earnings. It is the business’s long-term advantages which we seek to capture.

We therefore provide a range of valuations, usually based on discounted free cash flow. The lower figure of the range is consistent with the existing returns of the business assuming no further growth, and the upper end is consistent with our assessment of a reasonably attainable growth rate, given our current understanding of the business.

For us, free cash flow is pivotal. It is the basis on which a 100% owner would likely value the business, regardless of what dividends may be distributed, and it takes into account the capital expenditure required to maintain the operating capacity of the business. Indeed a decent quantum of free cash flow is something which many growth businesses fail to achieve. Conversely, for a growing business with low capital expenditure requirements we can often make the case that valuation is attractive despite a high PER. Key assumptions, and how we arrive at them, are disclosed.

Our range of valuations can be compared with the current share price to determine the extent of any overvaluation or undervaluation and commensurate margin of safety.