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.
Business Risk Factor
Here, I use the following to identify business risk:
- 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:
- Quick Ratio
- Debt/Equity Ratio
- Short Term Debt/Equity Ratio
- FCF to Total Debt
I think these ratios are self explanatory.