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Discounting Stock to Present Value

Wednesday, May 10, 2006
There are a lot of methods for deciding how much you will want to pay for stock in a company. Warren Buffett discounts cash flows of the whole business back to present value, and discounts a percent of uncertainty on growth. Then he discounts it with the current rate of the Treasury T-Bill.

The DCF or Discounted Cash Flows method of evaluating the company is very similar to this, except it does not count in the certainty of cash flows. Warren's method rewards stable companies and rates them better, but the DCF method discounts at the rate of a similar industry benchmark.

A less sophisticated method of evaluating a business, is the one I used before I started to learn much about investing. Basically, I divided the yearly eps by the share price to get a return on investment. This did not take into account a few key factors such as growth. It also does not give back a steadfast number, but a return that I later compared with other investments.

Hopefully this discussion of methods of valuating stock with present value was slightly helpful. Over the next few posts, there will probably be examples of how to calculate some of these numbers.

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