How these valuation models are built

A model starts from a company's reported financial statements and from analyst estimates, both supplied by a market-data provider. The share price is the one read on the model's date, and it is delayed. From there the model projects three or five years of revenue, profit and cash flow from ten assumptions: revenue growth, EBITDA margin, capital spending, depreciation and amortization, working capital, stock-based compensation, the exit multiple, terminal growth, the discount rate and the tax rate.

The facts quoted beside a model, such as a company's guidance or a remark from an earnings call, come from the company's own filings, releases and call transcripts. Each page lists the documents it rests on.

Every model holds three scenarios. Base starts from analyst consensus for revenue growth, where analysts cover the company, and from the company's last reported margin. Bear and Bull start as a lower and a higher version of Base. Any of the three can then be set by hand, year by year.

The label on a card (Bear, Base or Bull) names which of the three scenarios the card shows. A valuation page shows one scenario: the one its argument rests on. A scenario set by hand is the view of the person who built the model, not a forecast from analysts.

The exit method values the business in the final projected year. It multiplies that year's EBITDA, revenue or EBIT by the exit multiple, adds the company's net cash, its long-term investments and the free cash flow projected along the way, takes off the interest the company pays, and divides by that year's share count. The result is a target for a date three or five years ahead, not a value for today. The return shown beside it is the gain from the share price on the model's date to that target.

The discounted cash flow method gives a value today. It discounts each projected year's free cash flow, and a terminal value for the years after the projection, back to the model's date at the discount rate, and adds the company's net cash and long-term investments, all per share. The terminal value assumes cash flow keeps growing at the terminal growth rate.

Each page says which of the two methods its headline figure uses.

A valuation page carries up to four pictures, each captured from the model as it stood on its date.

• The model card shows the scenario's target or value, the share price on the model's date, the return between them, and the projection table behind it.
• The peer comparison card shows the company beside the peers chosen for it, with their valuation multiples and what the company would be worth at the peers' median.
• The sensitivity card shows how the per-share value changes when two assumptions move together. Its grids for the exit method are discounted to today's dollars: the target brought back to the model's date, which is why the middle of a grid is lower than the target.
• The Monte Carlo card shows the result of running the model 1,000 times with growth, margin and the exit multiple varied at random.

Each page answers one question: does the stock look undervalued or overvalued on this model? The verdict is a judgment, made after reading the model beside the company's filings, guidance and calls. It is conditional: every page states what has to be true for it to hold, and what would break it. It is an opinion about a price on a date.

Every page carries the model's date, which is the day the price was read, and the day the page was published. A page is a dated estimate and is not refreshed on a schedule. When its verdict or a figure changes, the page shows the day it was updated and a line saying what moved. A wording correction changes no date. A page never shows a price later than its model's date.

These models are built with the model builder in every Brief Equity account. For how we research, source and correct what we publish, read our editorial policy.