The Power of Earningshttp://www.fool.com/investing/general/2010/08/09/the-power-of-earnings.aspx Ron Gross and Andy Cross
August 9, 2010
Cold, hard cash flow. We talk about it a lot here at The Motley Fool. One method we've found to be very useful in determining the value of a company's current cash flow is earnings power value, or EPV. In contrast to valuation methods that require making uncertain growth projections, EPV is based only on a company's actual (trailing 12 months) cash flow. We can actually ignore growth estimates when using this tool, so this makes it a great starting point for analyzing a stock. Once you get comfortable with the formula, we think you'll find that it's a great method for determining what a company's current cash flow is worth.
EPV is useful because it can be calculated quickly using just a few data points. Stripped down, EPV is simply current adjusted cash flow, divided by the company's cost of capital, plus cash minus debt. And because EPV allows us to ignore future growth, another selling point is that it serves as a conservative measure of valuation.
EPV and Y-O-U
Operating income before depreciation and amortization (EBITDA)
- Depreciation and amortization
- Income taxes
Now divide this amount by the cost of capital (so if the cost of capital is 10%, then divide by .10) to get:
We use a few simplifying assumptions to make this formula a little easier to work with. For example, we assume maintenance capital expenditures are equal to 25% of total capital expenditures. Also, we use