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Valuing Publicily Traded Equity Securities: Black & Decker

Valuing Publicly Traded Equity Securities:
The Black & Decker Corporation (BDK)

I. Introduction
This teaching note describes the valuation of publicly traded equity securities using the Discounted Cash Flow (DCF) and Price/Characteristic (market comparison) approaches, with a specific spreadsheet example for The Black and Decker Corporation. Free cash flow valuation and comparables (comps) are key tools in fundamental analysis, the process of picking stocks with high expected return based on an analysis of the company. In theory, buying stocks of companies that are undervalued in the stock market will produce high returns as other investors slowly realize the company’s true value and quoted share prices increase to match that value.

Three basic ideas underlie the application of discounted cash flow (DCF) analysis. First, the value of a company is ultimately derived from the cash that can be extracted from that company, and more cash is preferred to less. Second, cash received in the future is not as valuable as cash received today. Third, risky cash flows are valued less than cash flows known with relative certainty.

The process of valuing publicly traded equity using DCF involves three steps. First, condensed financial statements, also called pro-forma statements, are forecasted several years into the future. Second, the forecasted statements are used to calculate free cash flows for the entire firm, which are then discounted by the cost of capital for the firm. Third, the intrinsic value of one share of the common stock is calculated as total firm value minus the market value of the debt, divide by the number of outstanding shares. The resulting intrinsic value of the shares can be compared with the current market price to inform buy and sell decisions. The objective of fundamental analysis in active portfolio management is to buy stocks with a market price that is substantially less than the estimated intrinsic value, and sell stocks...