# 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.

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.

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.

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

1. CY Koay says:

Hi LC,
Do you mind to share with me Business Risk Factor and Financial Risk Factor Excel file formula ?

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2. Jack says:

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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• L. C. Chong says:

I use [Total Liabilities]/[Total Equity]

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3. jack says:

Hi, where can we get the value of ROE, ROIC, CROIC?

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• L. C. Chong says:

For Malaysia stocks, you can easily get ROE from reuters or http://www.businessweek.com/. As for ROIC and CROIC, it is not common for Malaysia stocks, so you have to calculate it by yourself. For US stocks, you can easily find ROIC and CROIC.

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