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I'm trying to calculate the real value of a business and, as an example, I picked Netflix.

From their latest financial statements I can see that:

  • Assets value is: $3,065,709,000
  • Liabilities value is: $2,417,386,000

So, their book value is $648,323,000 (correct?).

Now, according to MSN, there are 55.36 million shares available.

So, if Netflix would have the above mentioned book value (is this the correct term?) and the above mentioned number of shares, then the real value of their shares is actually $11.711/share.

If Netflix were to (hypothetically) go bankrupt immediately (considering that the numbers would be up to date and not from Dec. 31) and their assets sold & any liabilities paid, the shareholders would get only $11.711/share back.

Are the above calculations and conclusions correct?

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And the kind folk at Yahoo Finance came to the same conclusion.

Keep in mind, book value for a company is like looking at my book value, all assets and liabilities, which is certainly important, but it ignores my earnings. BAC (Bank of America) has a book value of $20, but trades at $8. Some High Tech companies have negative book values, but are turning an ongoing profit, and trade for real money.

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No. The above calculation does not hold good. When financial statements are prepared they are prepared on a going concern basis, i.e. a business will run normally in the foreseeable future. Valuation of assets and liabilities is done according to this principle.

When a bankruptcy takes places or a business closes down, immediately the valuation method will change. For assets, the realizable value will be more relevant. For example, if you hold 100 computers, in an normal situation, they will depreciated at the normal rate. Every year, some portion of the cost is written off as depreciation. When you actually go to sell these computers you are likely to realize much less than what is shown in the statement. Similarly, for a building, the actual realizable value may be more.

For liabilities, they tend to increase in such situation.

Hence just a plain computation can give you a very broad idea but the actual figure may be different.

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  • +1 for mentioning going concern value vs. realizable value. But, re: "For liabilities, they tend to increase in such situation" ... Why might liabilities increase? – Chris W. Rea Feb 8 '12 at 14:30
  • Well there are many liabilities which is not accounted for as a going concern principle. For examples, labour retrenchment compensation which at times can be very huge. In such a situation, closure is made after negotiation with the Union. Similarly there may be unaccounted for Government Dues. There may cost associated with closure and their related liabilities. Dividend (on preference capital) may be outstanding. – Natwar Lath Feb 9 '12 at 1:39
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What you're looking for is the intrinsinc value of a business, which would be, strictly from a money point of view, if you buy the stock right now, how much cash would you expect back in the future?

If you expect a company to run indefinitely, which we have no reason to expect Netflix won't given its current success, you can run a discounted cash flow (DCF) analysis, which estimates from the cash flowing into the business, via revenue less expenses, how much you can expect back over time. This is sometimes called free cash flow.

From past earnings report (SEC forms 10-K and 10-Q's, or Yahoo Finance or your favorite finance website) you can get a sense of the rate of growth, discounted to the present (usually the opportunity cost of not having invested in something else that you assume to give interest forever, like U.S. treasury bonds). Since everyone has different investment choices available to them, at different amounts ($1k, $1m, or $1b), you should set this for yourself.

You can find the basic formulas here, to determine the discounted sum of free cash flow over a certain period where you have financial data (years 1 through n), and then a lump sum to approximate what it will be in the future, indefinitely (in perpetuity, where you have no financial data). http://news.morningstar.com/classroom2/course.asp?docId=145102&page=5&CN=sample

You can use the free cash flows growth over years 1 to n to estimate the growth over time expected for the , but you can also add in a margin of safety if you want to budget in future events that would severely impact cash flow, such as natural disasters, cyberattacks, etc.

I don't factor in inflation of, e.g. the U.S. Dollar, since assuming this is a U.S. company, it would probably affect this company's stock or any other investment you compare it to (discount it relative to) the same way. However, this may not be correct, if your alternative is to hold it in a different currency with a different price behavior.

Once you have the total cash disgorged in perpetuity, divide by number of outstanding shares, and you have the intrinsic value at the present moment. Play around with the discount rates and growth rates in a spreadsheet to see how instrinct value varies, and you'll get a sense that intrinsic value is a range, rather than a specific value.

Warren Buffett says that he doesn't even use a spreadsheet and doesn't need a lot of precision. After he's valued so many companies, he can look at financial data table (e.g.a Valueline report) and tell in 30 seconds whether a company is undervalued enough, and what volume of investment it can support.

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So, their book value is $648,323,000 (correct?).

Correct.

If Netflix were to (hypothetically) go bankrupt immediately (considering that the numbers would be up to date and not from Dec. 31) and their assets sold & any liabilities paid, the shareholders would get only $11.711/share back.

Not necessarily. You are conflating book value with liquidation value. There is no guarantee that the book value represents the amount of cash that would be obtained through a complete liquidation. Reasons include:

  • Liquidation process could incur additional costs (e.g. legal fees, administrative expenses, employee severance costs, etc.).
  • Fixed assets could be illiquid and hard to dispose, necessitating a lower sale price to attract buyers. (e.g. purpose-built buildings [e.g. factories], custom equipment, etc.)
  • The very likely possibility that the depreciation rate of assets in prior years may not have accurately tracked the real decline in asset values. Using book value to determine liquidation value of fixed assets could result in an over-estimation or under-estimation of the fixed assets' liquidation value.

Most of the time, shareholders are likely to get less than the book value (i.e. less than $11.711/share in your case) after a liquidation.

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