Valuation basics

The concept

Price is what the market asks for a share today. Value is an estimate of what the underlying business may produce for its owners over time. They can meet, but they are not interchangeable.

That estimate starts with business economics: revenue, earnings, free cash flow (FCF), reinvestment, and risk. Earnings are an accounting result; FCF aims to show the cash left after operating and investment needs.

Multiples such as price-to-earnings or price-to-FCF express how much investors pay for one unit of those results. They are useful shorthand, not automatic verdicts.

Why it matters

A strong company can be a weak investment when its price already assumes exceptional progress. A low-priced company may still be expensive if profits are shrinking or debt puts shareholders at risk.

Valuation turns a quote into questions about the growth, margins, and cash generation embedded in it. That is the bridge from wanting to invest to analysing a business.

A simple example

Suppose two companies both trade at €40 per share. One earns €4 per share and the other earns €2, giving price-to-earnings multiples of 10 and 20.

The second multiple might be reasonable if growth is stronger, more durable, and less risky. It might also signal demanding expectations. This example is illustrative and leaves out debt, tax, dilution, and other material differences.

What to examine

• revenue, earnings, and FCF over several years;
• conversion of profit into cash and the capital needed for growth;
• debt, share count, and exposure to economic cycles;
• multiples versus history, peers, and future prospects;
• growth and margin expectations already reflected in the price.

Context is essential: different industries, business models, and points in a cycle should not be compared mechanically.

Common mistakes

Treating a low share price as cheap valuation, selecting a multiple without understanding its denominator, and extending one unusually good year into the future are common errors. So is seeking a precise answer from uncertain assumptions.

A useful valuation works with ranges, tests scenarios, and records what would need to change for the conclusion to change.

Next step

Choose a business you can explain and trace how revenue becomes earnings and cash. Then compare several years, identify its debt, and write down which expectations appear to be included in the current price.

Use Research to move from the quoted price to the questions a company analysis needs to answer.