Trading using valuation models – Warren Buffet and Net Cash formulas to value a company

Trading using valuation models – Warren Buffet and Net Cash formulas to value a company

There are various ways to value a listed company. Fortunately, there is not one exact way to measure the value; otherwise, we would all get it right all the time. These variations and opinions on the way to value a company, provides buyers and sellers in the market place.

The most important thing is not to be hung up on random uncontrollable details. A trader must use the valuation models as an instrument to sort some conformity to the chaos in the market. It must be used a guide to help select trades that are profitable.

This is where the power of random statistical probability comes into play. Using a market-scanning tool a trader can quickly find and produce a list of quality companies that are trading roughly at or below valuation. Depending on the valuation model, and how conservative a trader wants to get, will depend on the various formulas a trader wishes to use. This formula needs to be modeled to suit the trader’s criterion. Each trader has a different perspective, so do not get hung up what other people are doing concentrate on what you’re doing and the results you are generating from your fundamental analysis.

Adding probability to the fundamental formula provides a trader the added reassurance of the profit that can be generated from a trade. By adding probability, a trader can also know how much profit is available on any given trade. This is highly valuable when working out if the trade fits your risk profile and the earnings to risk factor is in the traders favor. 

The way to look at it is to ensure that the company is trading below a valuation that you would be comfortable buying it. Here are some valuation models that may help with your fundamental models;

·        Warren Buffet formula

·        Discounted Cash flow models

·        Net cash formula

·        Graham formula

·        Peter Lynch fair valuation model

·        Net Current Asset Value

These are to name a few, but will help in your accumulation of data and models. All valuations models have limitations, and should be used as a guide.

The bottom line is creating a system that you are comfortable with, and then trade it. Trade it the best way you know possible and use the required instruments that provide you the return you are looking for. We will look at various instruments in a later blog.

Remember: NEVER TRADE UNLESS YOU KNOW WHAT THE POTENTIAL EARNINGS TO LOSS RATIO IS GOING TO BE.