What do You Want the Value to Be?
Financial Analysis for Investment (FAI) is an online short course that I teach in partnership with Gibs and MasterStart.
The course is designed to take an investment novice with no accounting, finance, or investment skills on a learning journey. The destination is a comprehensive performance and valuation analysis of a listed company.
Over six weeks, we cover basic accounting, financial analysis, and valuation. The focus of the course is the development of practical skills. We learn how to use MS Excel to manipulate accounting data and build performance and valuation models.
A key lesson is understanding that accounting data and reporting is a language that accountants use to communicate with other accountants. When measuring performance and value, accounting data is not very user friendly and needs to be “manipulated” to reflect a more realistic picture of a business.
Along the learning journey, we explore the dynamics of cash flow. We take time to understand historical cash flow, as reported by accountants so that we can forecast future cash flows.
The value of a business is its ability to generate cash in the future. Valuing a business is about determining what we are prepared to pay today for future cash flows.
Like all predictions of the future, there is a probability that the forecast will be wrong. In valuation, we call that risk. Part of measuring risk is knowing the opportunity cost of other investments we choose not to make. For example, what could we earn if we invested in an index tracker that returns an average market performance?
There are two motivations behind investing. They are greed and fear. Greed is wanting more, and fear is not wanting to lose what you already have. Understanding how those emotions exist in you helps determine the bias that you bring to your valuation process. Everyone has a bias; most people don’t take the time to examine what theirs is and how it impacts them.
When valuing a company, we discover that, despite many moving parts, there are just a handful of variables that significantly impact the outcome. In the final module of the FAI course, we explore these moving parts. We use an Excel valuation model to tinker with the variables and construct a set of feasible scenarios. In some respects, this is a process of reverse engineering what the market thinks will happen in the future to achieve a specific value.
Our job as prospective investors are to consider the likelihood of a scenario and judge if the market has mispriced a company. After all, opportunities to “get more” or earn returns that are higher than average come about when the market has mispriced an asset, and we can task advantage of that.
What is the value of this FAI course? The answer is in the title. What do you want the value to be? You could come away with the skills to find and invest in undervalued companies. Or you could change your whole world view on how you perceive value. Come across to the dark side and find out.