Understanding Discounted Cash Flow & Free Cash Flows | Candi Carrera | Skillshare

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Understanding Discounted Cash Flow & Free Cash Flows

teacher avatar Candi Carrera, Value investor & board director

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Taught by industry leaders & working professionals
Topics include illustration, design, photography, and more

Lessons in This Class

5 Lessons (55m)
    • 1. Introduction

    • 2. Understanding valuation

    • 3. Cash flow types

    • 4. Company valuation using free cash flows

    • 5. Conclusion

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About This Class

This investor quicktake course will allow students to have an easy & straightforward understanding about cash flows, why cash flow is an absolute valuation method and how to calculate a discounted cash flow.

At the end of this quicktake course, students will be able to differentiate between operating cash flow, investing cash flow and financing cash flow. Furthermore we will practice with Daimler/Mercedes & Kelloggs and calculate a discounted free cash flow to the firm and discounted free cash flow to equity.

Intention of this course is to be able in a short period of time to grasp the essence of cash flows.

Hope you will enjoy it

Meet Your Teacher

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Candi Carrera

Value investor & board director


Hello. My name is Candi Carrera and I am a value investor for more than 20 years with 90% of my personal savings invested in stocks. My main attitude as value investor is to buy shares as if I would be buying the whole company, acting as a business owner and understanding the business I am investing into.

I keep the remaining 10% as a cash reserve to buy more stocks as market corrections and bear markets happen regularly. During bear markets, investors are depressed and become pessismistic. I take the opportunity during those depressed periods of buying great companies at low prices. As famous investor John Templeton said : "If you want to have a better performance than the crowd, you must do things differently from the crowd".

Through these courses, my personal goal is to... See full profile

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1. Introduction: Hey, welcome back. Value Investors, welcome to this training on discounted cash-flow and free cash-flows. So as you remember, in my trainings, I like to use a multi-layered learning methods which is based on three layers. The first one being obviously content, and that's what we're going to practice today. The second one is practicing on real examples are going to share a couple of seconds on which companies we are going to be practicing our AI today. And then the third one is looking at webinars. So when we speak about this course compared to the other courses that you can find on the online learning platforms like Udemy skillshare, skill success. So this is a quick take series. So it's a new kind of series that I've built where in fact, I want you within a very short period of time to be able to understand a very specific topic without having the need to go through a full training. So the core reading keys and ideas of this take investor series around discounted cash-flow and free cash-flows is really to understand the three types of cashflows that you can find in a cashflow statements. Being able to understand where discounted cashflow sits in terms of evaluation methods for evaluating a company, evaluating in assets. And also understanding the difference between free cash flow to the firm and free cash flow to equity. But we're going to practices over the next 30 minutes in terms of contents. So we're going to start with what is all about valuation and the difference categories of evaluation that exist. We're going to look at the different types of cashflows. But first we're going to try to understand what's the difference between earnings versus cash flows because it's not the same, but they are linked together. And then we're going to discuss quickly operating cashflow, financing cash flow and investing cashflow that you're able to. We will be looking at in cashflow statement of any company, but it is a public equity, private equity company that you understand what's the difference between operating financing and investing cashflow. Then we're going to go into the core of it, which is a company valuation using a lot of people call it discounted cashflow. But the real term and I'm going to discuss electron is free cash flow to the firm. But we also be discussing Free Cash Flow to Equity and then obviously concluding the training. In terms of practice. Or you know, that I like that you guys as investors, that you practice your eye. And you know that I'm doing this from one now that in 20 years. So I really practiced my eye and this is what I'm bringing into my courses as well on real-world example. So here we are going to be working on Daimler Mercedes, which is a European company headquarters, headquarter in Germany. And you're going to be also practicing R and Kellogg's, which is a consumer defensive, so nutrition related or focused company from the US. So we have European multinational brands and also a US multinational brands that we're going to practice our eyes looking at cash flow statements. And as already sets, obviously, the webinars where you will be invited is once every month or every two months. There's going to be a webinar where you can participate with other investors and where you can ask questions directly to me and we will be discussing and exchanging on various topics. So that's hope you will be in joining this quick take investor course. And we're going to move into the introduction and discussing what it is all about variation. Thank you. 2. Understanding valuation: Welcome back value investors. So in this investor quick take discussing discounted cash-flow and most specifically free cash flow to the firm, Free Cash Flow to Equity. In the introduction, we need first to understand what is valuation and where DCF and free cash flow to the firm, Free Cash Flow to Equity where they sit in fact, in various categories of variation. So we're gonna give a very quick overview on that. So evolution is something that is very important. And as soon as we're done with Iran was saying, and if you're interested, I mean, this is a great book that I have from him that is called security analysis for investment in corporate finance At, done with their own is considered the guru of investing and he's a professor at Stern School of Business in New York. And he always said, and I like his statement that before you invest or when you want to invest intelligently, you need first understand what is the real worth of assets. And this is where evaluation comes into play. So the act of valuation is in fact, determining the reasonable or doing a reasonable estimation of an asset can be company, a public equity company can be private equity company, what that asset is in fact worth. So the objective of relation, there are two objectives related to valuation. The first one being pure information purposes. And you're going to have people who will do a valuation share that information with you. With the idea not necessarily of doing a buying or selling action behind it, but just and potentially going to monetize as well. The active evaluation can be a consultant, the appraiser. And then obviously and this is also what I'm doing when I'm doing valuation. The idea is I will be looking at the potential transaction so it can be buying a company. So as a value investor, I like to buy companies that are 25 to 30 percent undervalued or potentially selling the company that I have in my investment portfolio in the sense that the market is really crazy now about the market is overvalued getting the company. And if a violation is just unreasonable and unrealistic, are going to be selling out that asset, which are things that are actually did in the past as well and taking the profit from the sales so asset, so the people who'd be evaluating different people, some people will be on the buying side like potential investors. And there's gotta be a trade of between the buying side and the selling side. Because the buying side, and this is where when I'm on the buying side alike to buy the company as cheap as possible and not overpaying for the company. This is why I do the evaluation. But if you understanding side, you would like to sell as high as possible. And when I decide to sell, one of mistakes in my investment portfolio is trying to avoid too. I'm not getting I'm not gathering the supplemental price appreciation that would have received if what? If I would have stayed with that asset for a longer period of time? So trying to avoid under selling the asset. But in terms of categories evaluation when facts or we can classify two types of variation. We have the absolute valuation and the relative valuation. So most people, if I start with a relative valuation, most people, most investors either. So they look at relative valuation in a sense, they like to look at ratios. While I believe that ratios is not enough, you need also to look at future streams of cash and future streams of revenues and profits of the company. And this is where absolute revelation comes into play. So some people, and actually Warren Buffett was, let's say couple of decades ago looking at the book value of a company and was looking at the balance sheet of the company and doing acid-base valuation. It's something that I do as well. But what I do not like about absolute asset-based valuation is that you are missing the future streams of revenues and growth. This is where going concern evaluation comes in and going concern is in fact an accounting term that is used for companies that are financially stable. They will vary, probably live indefinitely. And this is where we find what most of the people called discounted cash-flow. And in fact, discounted cashflow is an absolute relation methodology. And then we're going to practice this in this quick take investor course. So if I summarize and this is an extract, in fact, of the main content of the art of company variation training, which is I think an eight hour training. It's very in-depth training. But here, what I wanted to share with you is I hope that you understand there are different types of valuation. So you have two types of absolute valuation. So acid-based which look at the current balance sheet, the current worth of the company and then going concern. And in the going concern, we find in fact, what we are discussing in this quick take investor training which is a set, a lot of people call it discounted cashflow. The real term is free cash flow to the firm, but also Free Cash Flow to Equity. And this is what we're going to be discussing. In the upcoming minutes. And then I said we have relative relation, which is more like a benchmarking and it facilitates actually the comparison between two different companies to different sectors, to different geographies. Even so that's, I would say more than 90 percent of the people they are fluent on relative valuation on a price to earnings, price to book those kind of things. But not a lot of people are able to do an absolute valuation of companies. And this is why I did this quick take investor training so that very quickly you are able to understand what it is all about and how you can calculate a discounted cashflow. So free cash flow to the firm and Free Cash Flow to Equity. Before wrapping up on the chapter run valuation, what you need also to understand is that valuation is an art and this is my, actually my trainings and Val as value investor, I call them the art of company valuation because it requires judgment and it required us humans skills and imagination. And if we look at free cash flow to the firm, for example, or free cash flow to equity, you need to think about some assumptions. The typical assumption that we're going to discuss in a couple of minutes is what is the actual growth that the company will have or that we think that the company will have over the next 10, 20, 30 years. Again, nobody has a crystal ball. What the growth will look like in the next 10, 20, 30 years. So it's an estimate, so it's an appreciation evolution that you will need to do. And there are many sources of errors. I mean, that's one because there is uncertainty about the macroeconomic environment. There's going to be uncertainty about, except if you're the shareholder, the main shareholder, owner of a company, you do not know how management will behave. I mean, I like to invest into companies whether it's a good management, That's attentive also on return to shareholders. But you do not know that. And then maybe misstatement in the financial statements as well because remember, and again, it's not the purpose of this investor quick take training. You may have financial statements, financial statements per default, or inaccurate. It's a representation of complex business processes. So those are examples of sources of iteration error. So, and actually Warren Buffett was saying this as well a couple of decades ago in annual shareholder meeting. When he looks at intrinsic value or intrinsic valuation of a company, it's not a perfect science. So he guesses there is an estimate and interval between value a and B, or value 1 and value 2. So there is a window where he believes the right market price should be of the company. And this is where he tries and I'm doing the same while we try as value investors to buy a company that is currently where the market price is depressed by the market and for no reason. And it will take certain time back to see the market price. And this is where the, let's say the profit opportunity is for us as value investors. Lost points here. Please remember that when we discuss about company valuation, it's not about financial analysis, that's something else. There's one or two, right? State this here. Financial analysis is really about analyzing the performance of the company, looking at stability, solvency, liquidity, and profitability, this is not what valuation is about. Violation is really trying to find what is the company worth and seeing if the market is under-pricing, overpricing or the seller in private equity examples, if the seller is under-pricing, overpricing the company. So with that, in the next chapter, we're going to be discussing the different cashflow types. Thank you. Stay with me and looking forward to the upcoming chapter. 3. Cash flow types: Welcome back investors. So in this next lecture, we will be discussing the various types of cashflows that you're able to understand and differentiate between the three types of cashflows. And also we'll be discussing difference between earnings and cash flows because that's not always clear to everybody why? People look at earnings versus cash flows are cash flows versus earnings and how both, let's say domains relates together both topics. So setting the scene, if you're in public equity, private equity or venture capital, or you want to evaluate a company. One of the main things during the due diligence that you would like to have is having access to the financial statements. And typically, I mean, most of the people know that there are two, maybe three financial statement types are the two would be the balance sheet and the income statement, which is also sometimes called the earnings statement. I typically like to have a look at the cashflow statement as well. So normally companies that are more mature, they will at least be able to provide you the three. So the balance sheet, the income statement, and the cash flow statement. So remember that the balance sheet is really the stock of wealth. Well, it has been accumulated from the moon that accompany has been created. So the what I call the moment of inception. While the income statement and the cash flow statement, they are looking specifically at a period of time can be a week, a month, two months, six months, a quarter, or a year. So this is where the difference is balance sheet. At any moment in time, you look at the balance sheet, you see the well that has been accumulated since the moment the company has been created. Why the cashflow and the income statement are on a specific period of time. And we're going to look, I mean, it's a investor quick take on cash-flow. We obviously will be looking at the cashflow statement. We're looking at the cashflow statement. There is a fundamental principle that you need to understand is the difference between income, earnings, it's the same versus cashflow. And in fact, those are two different accounting concepts. So you're going to have a ton difference between movements of cash versus how they reflect in terms of income earnings or business transactions in the income statement. But one key thing that I always like to remember my students is really at the end of the day, cash and earnings will converge. Otherwise, people are cooking the books, but those two principles will converge over time. I will try to make this visual in the upcoming slides. But remember that an income statement takes into account some non-cash accounting elements, such as depreciation for example, which gives some kind of tax advantages. So it reduces the tax surface. While the cashflow statement is very straightforward, it's really all the movement captures all the movement of cash inflows and cash outflows. And there is no conversation about depreciation and non-cash accounting items. So really, I mean, the good investors, they like to look at cash-flow or even some people say that cash is king because I mean, you can record a business transaction and you have sent an invoice to the customer. But if you never collect that money business, so really, a cashflow actually provides a much sharper picture of the ability of a company to pay creditors, but also how to finance growth from the cache that is being made available by the operations and also investing. And let me give a concrete example. So you see here a nice car. And we were speaking about dominant Mercedes. So it's a luxury brands. And I'm going to give you an explanation how you need to understand earnings versus cash flow. So we have the following scenario. So you have, let's imagine you are a limousine operator, so you provide services to people to travel from the hotel to the apple. Let's imagine that. And you have two choices. As a company owner, you can either decide to rent the car, so the car is not an asset's, it will not appear as an asset in the balance sheet. You will just be renting it from an external service provider and that service provider is remains the owner of the car. How is this reflected in terms of cashflow versus income statement? While in fact it will be the same because you will be paying, let's imagine a monthly fee for renting that car. And between the cashflow statement, you will have the operating expands and you will see the revenues as well. And income said Whatever the same, where you may have differences between cash flow and earnings as when you decide to invest into the car. And this is what I'm showing here in the second red frame in the car purchase scenario on the bottom of this slide, where instead of renting the car, you're gonna say, Well, guys, you know what? I want to own this car because I believe that I can, It costs me less and I can increase the usage and maybe be more optimal on the cost of maintenance of this covers as renting this from a service provider. And the difference and this is where you seen the two red trains difference between renting and purchasing in the car is the moment you purchase the car, you will have a full cash out of the car. Imagine the car cost 100 thousand US dollars. You will have immediately to pay out the car very probably to the to the seller, which is not the case when you rent the car. When you rent the car, this cost will be diluted over time, but at the very end of the day, you may have the option to purchase the car or you just want to go with a new car in terms of renting mole. And this is where there is an impact on the cashflow and this is where there is a difference between the income statement and the cashflow statement is that indeed, in the cashflow statement, if you're purchasing the car, you're going to see the full cash outflow of that car would you will not have if you are renting the car because this is a cache that is recurring cash out there is recurring over time depending on how you have been contracting the renting of the car, the sub-contracting of using that car, which is not part of your balance sheet. And then obviously we're not discussing here the balance sheet, but I could also explain that there is an impact on the balance sheet. When you purchase a car. That's car becomes an asset's, probably a long-term assets in the balance sheet. So it increases the value, the book value of the equity value of the company. While when you are renting the car, it will not appear as an asset in the balance sheet. It would just be considered as a cost of sales or cost of goods and sales as well. So that's really the difference. Important to understand that earnings and cash flow may differ over time. But again, at the very end of the day, let's assume that you would be renting out this cover five years and you would be buying it at a certain moment in time, the time that you have been using this car, let's say we're 55 years, you will be. So cash will converge with earnings and the cost of earnings. So at the very end of the day, over a longer period of time, both things shall converge together. So just be attentive that sometimes cashflow will vary, probably will differ from the earnings or income statement. So let's practice our I. So as I already said in the introduction lecture, we're going to discuss about dimers and receipts and Kellogg's, we're going to be looking at the cashflow statement. And if you look at the cashflow statements, because European company, our US, American company, you're going to see that actually you're going to see in the cashflow statement, the three categories of cash flows. You're going to have the cashflow that is provided by operating activities. Operational activities, you're going to have a cache. That is, the cash that is provided are used in investing activities. And you're going to have at the very end, at the bottom, you see here in green for both cashflow statements, you're going to have the cash that is being used are provided by financing activities. So for you as an investor, it's important to understand what's the difference between the three. So let's take a second to understand what's the difference between operating, investing and financing. So operating as the term already stated, it captures the cashflow of all operating activities linked to the core business of the company. So you will not have long-term capital investments are expenditures that you will see here is really what is core to the business. Then you have in the investing activity, you're going to see, for example, the example I was thinking of buying a car. You got to have at that moment in time, the full cash outflow of buying these Mercedes car, I said as an example, 100 thousand US dollars. The cash flow from investing activities will show this 100 thousand US dollars going out a little bit negative as it is, a cash outflow will be negative figure. At the same time if you are selling or disposing long-term asset. This happens sometimes when, for example, a company sells a manufacturing plant, for example, or sells a building, you will capture them the inflow of the sell-off cost of that asset as well in the investing activity. So it's not an operating activities and investing activity except obviously if buying and selling real estate is your core business, but for most of the companies it will not be. So if you're selling manufacturing plants, consider as one of effect and this will be considered as a disposal of a long-term asset and you will see it in the investing activity and not in the operating activities. Then at the very end of the day is an easy way. We are coming to the free cash flow to the firm and we're going to discuss this in the next lecture. He had the cash flow from financing activities. So this is actually what is remaining after operating activities, after investing and selling off long-term assets, what remains available to the firm, either to pay back debts or to pay back shareholders. And this is what we call the free cashflow to the frame. And we're going to practice this in the next lecture. So assets, remember that we have, So those three cashflows in a cashflow statement you sought in Domino Eurozone in Kellogg's. The two companies have operating cashflow. They have an investing cash flow and they have a financing cashflow. So in the next one will be, in fact doing a valuation on those two companies. And we're going to be discussing free cash flow to the firm and free cash flow to equity so that you get out of this investor quick take being able not only to understand, but having practice as well how it works. So stay tuned and hope to see you in the next lecture. Thank you. 4. Company valuation using free cash flows: Welcome back investors. In the next lecture of this investor, quick tag around discounted cashflow. We will be first of all understanding why people mentioned discounted, uh, why cashflows have to be discounted? And then we're going to go and do calculations on Download and Kellogg's practical calculation how to calculate the free cash flow to the firm and also the Free Cash Flow to Equity. But first things first is why people discounting the cash flows when they tried to evaluate what the company is worth. And specifically looking at the future streams of cashflow. And one thing that you need to click keep in mind is that money changes over time or the value of money changes of our time. The purchasing power of money changes over time. And there's a very good example, and I took the liberty of extracting this on the Master PR website where they were looking at a cup of coffee. And in 1970s, around half a century go into 25 cents of a dollar to buy a cup of coffee. While today because of inflation, it takes around $1.6 to buy the same cup of coffee. So you see that the purchasing power of money has evolved over time. If you look at from an inflation perspective, because that's typically what is driving up the prices of money over time. You can see that on this graph between 1970 and 2019, from 25 cents dollars for a cup of coffee to $1.59 for a cup of coffee. The average yearly inflation has been a three dot 8%. So it is actually inflation that makes the value of money change over time. And again, it's not the purpose of this investor quick take training, but typically give S role of the Federal Reserve in the US, the central bank in Europe to make sure that there is a little bit of inflation because that's better than deflation. But at the same time that inflation doesn't grow too much. And I mean, we're speaking end of 2021. That's currently a huge concern as money is very cheap. That we do have inflation all over the world. And the question you will be probably that interest rates will have to be increased by the central banks to, let's say, be a little bit more defensive on the inflation and control the growth of that inflation year over year. So the aspect of discounting money and you can sit in the calculation I made earlier. If you want to bring down the one that $59 for a cup of coffee to the value of 0, 25, you're going to use inflation, which is, let's say the cost of money. It can also be the return that you're expecting as an investor and then divide the current value and bringing this back 49 years earlier. And this is where we see that by calculating so the one that 59 divided by 1038, which means that it's one plus the three dots, 8% of inflation. And this compounded on a 49 year. So it's exponential 49 times, you're going to be ending in fact as 0, 25. So this is how we discount a monetary value, how we are going to be discounting a cashflow as well. Now this is done once, but you're going to see when we're going to be practicing free cash flow to the firm we're going to add. I'm going to start from the current cash-flow. We're going to look at the next 30 years, but stay with me on that. We're going to be discussing and practicing this in the upcoming minutes. So again, refreshing everybody's mind when we speak about discounted cashflow, we actually mean the free cash flow to the firm and Free Cash Flow to Equity is a subset of an absolute growing concern valuation of the company. And again, I'm just extracting you. There is this whole course called The, called The Art of company valuation. But we don't have the time in these in-vessel quick take we will be just focusing on free cash flow to the firm and free cash flow to equity. So when you think about free cash flow to the firm, and I really like to use the circulatory system of money. And starting on the right-hand side from the people that bringing money into the company, it can be, well, typically it is shareholders. At the moment of inception, they bring in cash, they decide to create a company, but can also be credit TO laws like the investors decide to take a loan at the bank. So the bank becomes depth dollar credit holder. Typically the circulatory system goes the following way is that cash is brought in by either investors or lenders. The management of the company decides to transform that cash into real assets. Imagine a car. It can be in manufacturing plant, it can be, I don't know what it is building. And in the hope that through those real assets and through the operation of those assets, the company will be generating a profit. What happens then? So that's after the flow number 3 happened. The flow mentions that knew of fresh cash has been generated by operations. Senior management has to take a decision aid of the reallocate the result and the profit into the operations. And, and try to grow even further. The company tried to develop even further the market, the customers you name it, or until it ends, because it's not just one or the other. Very often it's a mix of keeping a little bit of that cash and putting it into back into real company operations, into real assets. And then there are two ways of, and this is the free cashflow that remains and it will go back to the firm. So the firm is here actually defined by, first of all, paying back debt to the creditors or reducing the amount of debt that the company is carrying. And the other flow that goes back to the shareholders. Then giving some kind of written to the shareholders, to the equity holders is what we call the Free Cash Flow to Equity. And this is where we are going to be using dividends. We're going to use share buybacks, those kind of things. So the free cash flow to the firm is what you've seen in the graph diagram is the flow for a and for B. So it's cash returned to the creditor, Ola's and as well to the investors, to the shareholders. So the free cash flow to the firm, which is generally known as discounted cashflow, in fact, represents the amount of cash that is available after operations and after depreciation expenses and working capital changes and investments have been deducted. So basically you sit on the arrow. The free cash flow to the firm used is very straightforward. You add operating activities. So the cashflow from operating activities, and you add to that the cash flow from investing activities. What is important here is that the formula, as I'm showing it here in the slide, states that you just make the sum of the two. And typically the cashflow from operating activities will be positive and typically the cash flow from investing activities will be negative. That's what happens in a typical company. The company will generate a profit from operations. That's why the casual would typically be positive or it's not always the case. And you're going to have a cash flow for investing activities. A company will be investing further into new assets and typically they're going to spend money. So that's why typically the cash flow from investing will be a negative figure, but do not worry about the signs. Just make the sum of the two because sometimes I set, you may have the cash flow from operations that will be negative, which is obviously not a good sign. And also sometimes the cash flow from investing which may be positive. And this could be linked that the company has been selling out part of the assets and there is a huge cash inflow coming in. That's more exceptional, but it may happen. So just thing that you need to add the two together and this will give you the free cash flow to the firm. And remember, the free cash flow to the firm is what remains available in terms of cash, pay back debt holders and to bait to pay money back to the shareholders equity holders. If now we practice this, Let's look at the cashflow statement of diamond hard. So remember we looked at the cashflow statement you have in black, the operating cashflow, you have in red, the investing cashflow, and in green the financing cashflow. So remember that free cash flow to the firm is, you sum up the cash provided by operating activities, which includes the profit before income and taxes, and you add the cash used for investing activities. In this example, domino, we're looking at the 2020 annual figures. The company has been generating 22 dot 3 billion of euros or 22000, 332 million euros of cash provided by operations. And the company has been investing or has been using six dot €4 billion of money to invest further into assets. So which, if you add those two together, we end up at a free cashflow to the firm of €15.9 billion of €15,911 million. So that's the amount free cash flow to the firm. That's the amount that remains available in order to pay back dept. And, or potentially also give a return to the equity holders. Kellogg's now, same principle, again, the same way how to read it. You have the operating cashflow. In the black frame, you have the investing and the red one and the financing and the green one. So you see that in 2020 we're looking at annual figures again, the company has been generating, generating 109, 86 billion of US dollars of cash provided by operating activities. And the company has been spending a little bit more than 0.5 billion of US dollars or 585 million US dollars in terms of investing activity. So free cashflow to the Fermi's what? Just make the sum of the two. And you end up at 1 dot 4 billion US dollars that remain available to pay back debts and to provide some money back or some return back to the shareholders. So what is important here also to understand is that free cash flow to the firm, as we have now calculated, it, is just on one specific period. We were looking at annual figures. If you want to be able to understand what is the intrinsic value of the company. So what we call the discounted cashflow, we will need first of all, to discount this and do this on a longer period of time. And we're going to be practicing this now on a 30 year period and using the actual file that is part of this training as well. Last but not least, before we continue. Keep in mind that also here, doing a discounted cash flow or discounted free cash flow to the firm calculation over 30 years requires some judgment because you have to start with some amount of free cashflow. The question is, are you taking the last year? Are you taking an average of the last three or five-year? So here, judgement is actually required. We're going to be doing it here purely on the last annual year, on the last annual free cash flow to the firm for Daimler and Mercedes and for Kellogg's. And as already stated, so in order to be able to estimate what is the company worth, remember that we are looking at absolute valuation. One of the cons of asset-based valuation is that you're only looking at the current book value of the assets in the balance sheet, which is worth something. Warren Buffett has been doing this for many, many years. But then Warren Buffett was also very clear to say, and this is what i'm, I'm remembering you here as well. You do buy companies not just for what they're worth today that is reflected in the balance sheet, but also for the amount, or more specifically for the amount of profits that they're going to be generating over a certain period of time. Here, what we're doing is we're going to look at free cash flow to the firm and we're going to look into it for the next 30 years. One important thing to mention here is when you look on the internet or other trainings, people tend to use a terminal values or after the 30 years they do a last day, some last indefinite amount of cashflow that goes beyond the 30 years. I tend to avoid this because I believe that it increases artificially. The value of the firm can be discussed, but I prefer to stop after 30 years. And then really thinking about what is a growth. So I need to have a couple of variables and you need to decide, first of all, what is the number of years. So for me it's 30. Without terminal value, I need to decide and to define what is my expected return over the next 30 years, I will use something like between 6, 7%. We're going to think in this example I will be using 6 percent, but you can change this in the actual file. And then obviously the cashflow, you need to decide if the cashflow remains constant or at least. And this is what I will show you for the Dymola and Kellogg's as those companies will grow, at least, I'm hoping that they will grow at the same pace of inflation. So I'm going to put in there for the next 30 years are going to grow every year by 3%. Which fields? Reasonable to me, some people will say it's underestimated. You should put in 10 percent for the for the first 10 years, then five and then three. That's why valuation is an art because it requires judgments and it requires thinking. For me here in this example, I'm going to put 6% in terms of expected return, 3% of growth year over year for the next three years and no terminal value. And again, I'm doing this on 30 years, as already stated, but you could do it on 20 on ten as well. So now coming to the free cash flow to the firm calculation. So we are using the 15, 9, 11 million euros as the starting point. And again use the actual file we're going to put this in. And what we also need is the amount of outstanding shares so that we can bring the free cash flow to the firm, to a per share valuation and then compare it to the price that the market is giving us. So here what we're going to be doing is I start with 15, 9, 11, 9, 11 billion euros of cash flow free cash flow to the firm in 2020. And I'm saying that, as I said, I'm expecting a 6% return every year. So I'm going to be doing this over every periods. And also, so that's the cost of money actually. And I am expecting that the cashflow grows by 3% every year for the next 30 years. So when we do the math and the exit file does the calculation for you, we see and again, it's not a solicitation to buy dime LA at the current share price of 82 dot 11. I in fact bought Dymola at €51 a share. And so that the free cash flow to the firm per-share. So you are making the sum of all the cash-flows discounted over the next three years. And you divide it by the number of outstanding shares, which is one dot 070 billion of shares in faith gives an intrinsic value of 286. So obviously, when you do the calculation current market price to the real value of a share, you see that we're at 28 percent, so 028, so currently and it looks like the market is underpricing dime LA based on the latest free cashflow. So you can have a conversation. Shall we take an average of 1000, 99, 2018. That's your judgment. I'm not telling you that you should by now, but I'm just showing you how to calculate this starting from the free cash flow to the firm. If you do the same for Kellogg's, Kellogg's the same attributes, 6% expected return. I'm expecting in Kellogg's to grow 3% per year for the next 30 years. And the number of outstanding shares is currently at 340 dot 88 million of shares outstanding. That's something that you find in the financial report of the companies. So the free cash flow to the firm per share is 79, 10 US dollars. Which means that if we calculate the price to value at the current share price of 62 dots 12, you divide this by the free cash flow per share. So the calculated value. It looks like the market is underpricing Kellogg's by 22 percent. Again, it's not a solid station to buy Kellogg's. I bought Kellogg's, I think at around 55, 56. So I, again, there is also an interesting, we're going to be discussing a Free Cash Flow to Equity as well. So why my money sit still, I get also passive stream of revenue. So this is a free cash flow to the firm. So what we did here in the bottom red frame is what people tend to call a discounted cash flow calculation. So this is basically what we are looking here, but the actual file that I've prepared for all the students does this calculation for you, but you can see actually how the discount works and you can play with variables in terms of maybe you want to have a higher expected return as investor. Maybe you want to be more aggressive on the growth and go with 5%, 4, 3% percent. I do not know that's something that you can do, of course. So as already stated, the free cash flow to the firm is the amount of cash that remains available after operational activities and after investing activities. And that money is then used for paying back depth potentially can be also an inflow of new depth. So raising new depth of corporate obligations and then also cash or some kind of return to shareholders. Now the second cashflow that we tend to speak about is what we call the Free Cash Flow to Equity. The Free Cash Flow to Equity, I literally States, we have in fact already shaved off the credit conversation, the depth conversation. So it's just the amount of money that goes back to equity holders. That's why it's called the Free Cash Flow to Equity. And so, as I already said it earlier, the Free Cash Flow to Equity is a subset of their free cash flow to the firm. The difference between the two is that has really been paid off respectively has been already added if there is an inflow of fresh depth. So there are three ways of looking at Free Cash Flow to Equity. The most easy way is what we call dividend discount model. So what is a way of giving a dividend back to shareholders, or sorry, giving a return back to Charlotte is by paying out cash dividends. And the formula is very easy, is you take the dividend per share, which you will find in the cashflow statement, and you divide it by the cost of equities, which is basically the return that you're expecting. Then you have because it happens for some companies, that's one of the reasons why I've been investing into Kellogg's, for example, Kellogg's has been growing is what we call a dividend aristocrat dividend King has been growing the amount of dividends per share over the last decades. So basically, the dividend per share will be growing over time. So it has to be somewhere reflected in the calculation of the Free Cash Flow to Equity. And that's what we are doing in the second formula, where the value of stock, it's also called the Gordon Growth Model, is you take the dividend per share divided by your expected returns of causal of equity, but you subtract the growth rate. So if you have a 3% growth rate on dividends every year and your cost of equity is 6%, you're going to be dividing the dividend actually by 3% and no longer by 6% as what we were seeing in the dividend discount model. But we're gonna practices are going to show how to calculate this. And then the one that I typically use, and that's the one that we use also in the, in the Excel file in the trainings is what I call the total shareholder yield. So there's one conversation that has to be added back and we're going to see this in the cashflow statement of Dharma and Kellogg's. It may happen that companies prefer, instead of paying out the cash dividends to shareholders if they prefer. In fact, buying back shares directly from the market. So reducing the amount of outstanding shares is what we call the share buyback. And in order to capture that the formula goes dividend per share plus the amount of share buybacks per share. And we divide it by the cost of equity. Would be growth rate. Subtract your expected returns of cost of equity by the growth rate. If there is no growth rate, is my cost of equity minus 0% because there is no growth in dividends. So it's a pretty easy formula. Dividend per share plus a shabby per share divided by the cost, divided by the cost of equity. So without going into the conversation, there are different types and I'll let you read this through because I wanna stick to my 30 minutes and investor quick take the different types of dividends that exist, not all the dividends existing cash on a cash form, you may have warrants, you may have scrip dividends and share buybacks. That's something that appeared a lot of the last, let's say, two decades, where actually the company, instead of paying out cash dividends, a preferred to buy back shares directly from the stock markets and was retaining them those shares as what we call treasury stock. Treasury shares in the balance sheet, in the equity part of the balance sheet, which reduces the amount of outstanding shares and buy that your valuation. So the intrinsic value of, for example, the free cash flow to the firm. Per-share, in fact, increases, some people will say artificially, but the company has been spending money on buying those shares back from the markets. Also something that's we're going to want to see in the next, in the cashflow statement of dominant Kellogg's is. It's not just about share buybacks, but it happens as well that companies remunerate. Are they pay part of the salary in stock options? That's typically something that is done in growth stocks and also in the venture capital, capital world in startups. And obviously this has to be captured because if you print, if the company prints new shares, that's, that has a negative effect on the yield that shareholders will get to cause the amount of outstanding shares is actually increasing. So you are dividing the value of the company, buy more shares, which then reduces the amount intrinsic value of one single share. So let's look at now at the cashflow statement of dominant in the green parts here. You see that I've purely isolate it, the Free Cash Flow to Equity. So we have here dividends paid to shareholders. We have proceeds from the issue of share capital, that's new shares that have been printed. So domino has printed 31 million of shares. They have they have pain back 963 million to share a loss and a 182 to non-controlling interests. So we're going to focus on the 163. And also they have acquired from the market €30 million. So actually they have been offsetting I going to sell, it's a net non-zero operation. They have been offsetting the proceeds, the printing of new shares by compensating this, by acquiring with the same amount of shares, which basically does not have an effect on the diluted weighted average shares outstanding. Kellogg's the same. We're looking at a part of the financing cashflow. So here you see that they have issued 112 million of new shares that has a negative effect on their return to shareholders equity holders. And there have been paying back 782 million US dollars. And you see from the 10192018 whether it's fingers, you sit in the red frame, sorry, in the green frame, you see that the amount of cash dividends being paid out, you already seen over the last few years has been increasing from 76 to 27692782. And this despite the COBIT. And this is why I like Kellogg's because Kellogg's is actually increasing their dividends year over year. So net-net to the free cash flow to equity, so 670 million US dollars. Now we do the calculation for diamond and Kellogg's. So Dymola had a Free Cash Flow to Equity of one dots to 44 billion euros and are going to remove the non-controlling interests because that's dividend that we as public shareholders, we will not see. And I consider that the proceeds actually they net out the acquisition. So I'm seeing it's a 0 operationally, I should have actually corrected by a plus 1, which is difference between plus 31 and minus 30. So we'll be looking at the share price from a dividend discount model. The company has been paying out €963 million of dividends divided by 6% of return. So that's my cost of equity and divide it by the number of outstanding shares Dom La had in 20 twenty one billion, seventy shares. This gives me an intrinsic value of 15 year-olds. And the Gordon Growth Model, the dividends have not been growing for Dymola. And as there is no share buyback or actually it's netted out by the printing of new shares. That's a 31 minus 30, that's one. In fact, the real calculation should have been 964 or the total shareholder yield divided by 006. And an actually this gives me a 15 Euro intrinsic value versus an 82. So we see that the Free Cash Flow to Equity is telling me that Dymola is overvalued at an amount of 82, which is currently AT 2011, the share price. If a look at Kellogg's, Kellogg's, we have the Free Cash Flow to Equity. So they have been paying back dividends for 782 and divide this by 6%, which is my cost of equity. And divide this by the weighted average amount of shares outstanding, which is $340.88 million, which gives me an intrinsic value on the free cash flow to equity per share. It's not, it's no longer free cash flow to the firm. It's free cash flow to equity, which is a subset of free cash flow to the firm of 3800, 23 US dollar. Then if we take the Gordon Growth Model, remember that the amount of dividends is increasing every year. So here I'm reflecting an average 15 percent of growth of dividends year over year. So I'm no longer dividing 782 by 6%, but I'm dividing it by 6% minus the growth to capture the growth of dividends over time divided by the amount of weighted average stocks outstanding or shares outstanding. So I have now an intrinsic value calculation of the Free Cash Flow to Equity by share of 50 dot 97 US dollars. And then if I want to be really complete, I need to take into account that Kellogg's has been printing for a 112 million of new shares lossy, which has a negative effect. And you see through the calculation, because I can no longer just say that the dividend per share of the total amount of dividends paid is 782, but I need to subtract the 112. So actually the total return to equity holders has been 782 minus 112 divided by my cost of equity and then the growth and dividends. That's only giving me an intrinsic value of 43, 67 years dollars. But remember, this is a Free Cash Flow to Equity. Typically investors, they look at their free cash flow to the firm to do the over or under valuation or what is called the price to value ratio. And to see if you have a safety margin like you would when you would buy a share. Now actually our shares now from that company. So wrapping up and before going to the conclusion, so wrapping up this lecture, I hope that you understood the why money is being discounted because it changes so that the purchasing power of money changes over time. And when we speak about discounted cashflow, that we in fact mean the free cash flow to the firm over a period of time where you need to bring in what is the amount of years that you're looking at? I'm typically looking at 30 years. What is the growth on the cashflow that you're expecting? And there is judgment is required on this for the next, for example, 30 years. And and, and basically doing the sum of those 30 years gives you the future streams of free cash flow to the firm for the next three years. And you divide this by the number of outstanding shares currently. And this will give you the intrinsic values of the free cash flow to the firm per share, which typically people call discounted cashflow. But I prefer to be precise, as I've been learning from us, what demoed around as well is it's called free cash flow to the firm and not discounted cash-flow or you call it discounted free cash flow to the firm. With that, talk to you in the conclusion lecture. Thank you. 5. Conclusion: Welcome back investors. Very quick conclusion on this investor quick take around discounted cash-flow. And you have understood from the previous lectures that we were in fact redefining discounted cashflow, discounted free cash flow to the firm, and or discounted Free Cash Flow to Equity holders. So as a conclusion again, just repositioning that discounted cashflows, but it's typically called discounted cashflow, as you understood now, free cash flow to the firm. Free Cash Flow to Equity, basically an absolute going concern valuation method. You want to know more about the other ones that you see here in the summary diagram. Please go into the art of company valuation training, which is a really I think is an eight hour training. Whether you want to practice all those evaluations. Ovulation method, starting with the acid-base balance sheet based valuation methods than going for the going concern absolute valuation and then going for what we call the ratios as well. So the relative relation, which is typically something that most of the investors out there in fact used to benchmark companies and to see if they are cheap versus the market and other competitors or other industries as well. And so, if I have to summarize, so remember when you look into discounted cashflow that you will need to determine a certain amount of investment variables you need to define are determined you expect your written as an investor. I typically like to have it in six to 7%. Currently it's 6% because interest rate is very low. If interest rates are growing, obviously, my expert written will be a little bit higher. So it's what is called the risk premium. You need to decide on future growth assumptions. You need to decide if you want to use a terminal value or not. And as I've been discussing and sharing transparently with you, and that's the intention of those of those trainings, are these turnings that I'm doing for you guys? It's my personal choice is only 30 years. As I have learned from Warren Buffett, no terminal value because it will just make the business case better. So I want to be a little bit more conservative currently my expected return is 6% because money is cheap. So investing into equity with interest rates that are close to 0, I'm okay with 6%. And then the growth assumption that I need to factor in the Excel file and please do use the exit file. Practice your eyes on that. It will really depend on the industry. So obviously, when I look at consumer defensive companies like Kellogg's with nutrition, probably are going to put something in which is close to the growth of inflation or to the demographic growth of the markets that they are in. So, and this is where you're going to see me as very invasive. Be a little bit more defensive Milligan to put in 5% for the first 10 years, then 4%, 3, it will for sure not be 0 because it's going to be inflation. So at least they're going to affect or some kind of growth on the cashflow that will have an impact on the future streams of revenue over the next 30 years. With that wrapping up here, I hope that this formula of investor quick takes is valuable to you. And looking forward to speak to you either during the next webinars or that we would probably be able to exchange in the next trainings that I will be publishing. Thank you very much. Okay.