Glossary (Key terms and their definitions)
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20 key terms and their definitions
1. Valuation
Also known as stock valuation, it is the process through which you can determine the value of a company’s stock.
2. Time value of money
Time value of money is a concept that states that the present cash in hand is worth more than an equivalent sum that you earn in the future. This is because money loses its value over time, thereby lowering its purchasing power.
3. Intrinsic value
The intrinsic value is the real and inherent value of a stock. The market value of a stock may not always represent its true and fundamental value, thereby necessitating the process of valuation.
4. Discounted cash flow (DCF)
The discounted cash flow method is a technique that’s used to value the stock of a company. It uses the concept of time value of money. The DCF method discounts all the future free cash flows and the terminal value down to their present value to determine the value of the company.
5. Discounting
The process of conversion of the future cash flows of a company to their present value is known as discounting.
6. Discount rate
The discount rate is essentially the interest rate that’s used to convert the future cash flows of a company back to their present value.
7. Free cash flow
Free cash flow refers to the cash that remains with the company after it pays off all of its capital expenses and operating expenses.
8. Terminal value
The terminal value is the value of the company for the period that comes after the years for which you’re forecasting the future free cash flows in the DCF method.
9. Terminal growth rate
The growth rate at which a company is expected to grow for the foreseeable future is known as the terminal growth rate. It is also known as the infinite growth rate.
10. Dividend discount model (DDM)
The dividend discount model is a valuation technique that utilises a company’s dividend payouts to determine the value of its stock. Since a company distributes dividends to its shareholders from its free cash flows, this model assumes the dividends to be an accurate representation of a company’s free cash flows. This is primarily the reason why the DDM utilises dividends rather than free cash flows.
11. Asset-based valuation
The asset-based valuation method determines the value of a company by computing its net asset value, which is the total value of assets minus the total value of liabilities. It has two different approaches: the going concern approach and the liquidation approach.
12. Market value valuation
The market value valuation method involves comparing the value of similar companies that have recently sold off to determine the value of a company’s stock. It is a relative valuation technique and is one of the simplest ways to measure a stock’s value.
13. Due diligence
Due diligence is the process of examination of the various aspects of a company to ensure that all the facts presented are true, accurate, and fair.
14. Legal due diligence
The process through which the legal aspects of a company are thoroughly investigated is termed as legal due diligence. It involves looking beyond the financial statements and into the various legal issues of the company to ensure that the entity doesn’t contravene the applicable laws, rules, and regulations.
15. Accounting due diligence
Accounting due diligence is the process of inspecting the various accounting policies and practices of a company.
16. Price to earnings (P/E) ratio
The price to earnings ratio establishes a relationship between the current market price of a company’s share with its earnings per share value. It is calculated using the following formula.
Price to earnings (P/E) ratio = current market price per share ÷ earnings per share |
17. Price to sales (P/S) ratio
The price to sales ratio establishes a relationship between the current market price of a company’s share with its sales. It is calculated using the following formula.
Price to sales (P/S) ratio = market capitalisation ÷ total revenue |
18. Price to book value (P/BV) ratio
The price to book value ratio establishes a relationship between the current market price of a company’s share with its book value per share. It is calculated using the following formula.
Price to book value (P/B) ratio = current market price per share ÷ book value per share |
19. Price to cash flow (P/CF) ratio
The price to cash flow ratio establishes a relationship between the current market price of a company’s share with its operating cash flow per share. It is calculated using the following formula.
Price to cash flow (P/CF) ratio = current market price per share ÷ operating cash flow per share |
20. Enterprise market value (EMV)
The enterprise market value is a valuation method that determines the total value of a company. It takes into consideration the company’s market capitalisation and its total debt minus the cash-in-hand.
Enterprise market value (EMV) = market capitalisation + total debt - cash |
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