Company Risk Factors to Determine Discount Rate and Margin of Safety

If you notice, in my DCF and Absolute P/E valuation, there are two parameters I use to determine Discount Rate and Margin of Safety: Business Risk Factor and Financial Risk Factor.

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I adopted the ideas from www.oldschoolvalue.com in doing this. You can see my calculation of Business Risk Factor and Financial Risk Factor in another worksheet.

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Business Risk Factor

Here, I use the following to identify business risk:

  1. ROE
  2. ROIC
  3. CROIC
  4. Intangibles % of Book Value

The first three are self explanatory. The reason I use intangibles as a percentage of book value because I do not want businesses to grow by acquisition which could lead to issues later on. Growth through intangibles is not a good business model and is not a competitive advantage.

High intangibles does not necessarily reflect business risk, but continually growing intangibles is a warning sign for sure.

Financial Risk Factor

The four numbers that make up financial risk are:

  1. Quick Ratio
  2. Debt/Equity Ratio
  3. Short Term Debt/Equity Ratio
  4. FCF to Total Debt

I think these ratios are self explanatory.

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6 thoughts on “Company Risk Factors to Determine Discount Rate and Margin of Safety

  1. Hi, thanks a lot for the information! I try to count the short term debt/equities using data from equitiestrackers => (Total Current Liabilities/Shareholders’ Fund) but i got a much more higher value. I’m using recent HAIO analysis which you did as an example. Would you mind to enlighten me?

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