Intrinsic valuation is a critical technique in evaluating the price of a commodity or share in the market. In the case study given, the following could be the missing pieces that led to the wrong valuation of the price of the stock shares.
1. Using wrong beta for valuation
The value for beta is normally gotten by getting the difference in values between the expected return and the risk-free rate. It is greatly dependent on regression analysis and data inputs. If there are increased discrepancies for the beta values, it will trigger the application of many analytics on the expected return. For instance, the case whereby the shares of a company were valued at 49.47 USD in two weeks, up from 14.17 USD, indicates that the used beta value was large. Under normal circumstances, if the beta value used in the valuation is very small, it will be less significant to the valuation of the product. Therefore, different beta values will yield different estimate values, proving to be a missing piece in the valuation of the stock share.
2. Using the wrong formula in leveraging the beta
If the range for the beta values differs significantly, then the estimate for the stock share will be different from the expected value. In calculating the risk-free rate, if a bigger value is used for beta, the risks are high and vice-versa. Companies employ appropriate formulas to help them determine which beta value to use when necessitated by a move to alleviate itself from debt. Similarly, the creation of debt by a company is proportional to the beta value used. The mistake can be avoided by keying in the right figure and ensuring that the beta values are in the right range. Also, companies are supposed to avoid manipulating the beta values to get what they want and use all three betas (high, low, and average).
3. Wrong calculation of the value of tax shields
Suppose a company plans to increase its debts. It will use the current value of the tax shields, which is discounted and has appropriate leveraging. On the other hand, if the company forecasts to make a profit, it will use a different value of tax shield.
4. Wrong calculation of the WACC (Weighted Average Cost of Capital)
To get the right WACC value, one must know the equity and debt value. Using the correct WACC value leads to a reduced equity value. In this case, the equity value is 14.17USD, and the debt value is 35.32USD. Also, if a company uses a statutory tax rate in preference to the effective tax rate of the levered company affects the WACC. Further still, the WACC values should be gotten from the debt and equity values.
5. Catastrophes
Catastrophes and any other unpredicted event adversely affect the market, leading to other risks such as political instability, capital transfer controls, and currency devaluation. Therefore, if a company needs to calculate the beta value, it will base its’s value on the country’s risk, especially if it is a developing country. Again, to determine the beta value of a large economy, a company will need to focus on the regression of the return on its stock exchange index.
Wrong evaluation of Cash- Flows.
This is yet another critical factor in determining a stock share price. When considering the right price for a stock share, a company needs to check the cash flow systems, including cash balances and near-cash investments concerning the value of operating assets. Numerous companies compute the current values of expected cash flows and add the company’s cash while there is uncertainty for the company to continue being strong in the subsequent years. Adding all the cash is detrimental since it cripples its financial ability to run its operations. Also, there is no provision to distribute cash immediately. Conversely, it will only deem better to add the cash when the interest received on the cash is equally proportional to the interest arising from debts. Again, if the cash is distributed immediately, it will be well deemed fit for the addition of cash activity.
Overall, the company will benefit from hindsight experience to correct the errors or the missing pieces that led to a serious intrinsic valuation.
References
Bouwman, C. H., Fuller, K., & Nain, A. S. (2009). Market McAllister, P. (1995). Valuation accuracy: a contribution to the debate.
Journal of Property Research, 12(3), 203-216.valuation and acquisition quality: Empirical evidence. The Review of Financial Studies, 22(2), 633-679.
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