Bingo!
What I like about this approach is that I don't have to be thinking about what is the 'true value' of the business (if there even is such a thing) and I don't have to think about what is the right discount rate (if there even is such a thing) and I don't have to be thinking about nonsense like AWCC. Sometimes thinking about that stuff feels a little like a rooster might feel trying to lay an egg. I lot of effort, but not much action.
You can simply ask, do I like this yield for this business? If you construct your EP (if I can continue to use that term), and your EBIT (think more effective earnings), with a little more sophistication, you can even treat it as an estimate of expected return. Then you can really start treating all opportunities as equals (from buggy whip makers to Thai massage centres, to misquote Buffett).
Ultimately it then just becomes an analytical (rather than numerical) form of a DCF, except instead of calculating intrinsic value, you are finding an expected return (IRR).
V = c/(R-g) + A
where:
V = intrinsic value
c = next years fee cash flow, or owner earnings, from operations - after deducting cash-flows required to fund growth
g = expected growth
A = present value of non-operating asset (or -ve for liability)
R = required rate of return
To keep things simple, we can reduce growth to zero, and then include all free cash-flows (or owner earnings) in 'c' (ie just value all 'c' as if they are paid out to shareholders (this may be non-conservative, depending on how well capital can be re-invested).
Then we have:
V = c/R + A
where 'c' now captures all owner earnings (or FCF), without deducting retained, or re-invetseed earnings (beyond 'stay-in-busines requirements).
If we then use P (price) instead of V, then we have:
P = c/R + A ,where R is now the expected rate-of-return at price P.
Hence:
(P-A) =c/R
R = c/(P-A)
Now as P-A is what I previously refereed to as 'effective price' (generally referred to as EV), then:
R = c/EV
Here, for simplicity, I have ignored any income derived from the asset A (such as interest). The key however, is that the face value of 'A' may not be appropriate. It is the present-value to shareholders that matters. For instance, a business may have a lot of surplus cash that sits idle for years and years. Without you having control, that cash is of less value to you than the face value. Similarly, debt may be a lesser liability than the stated amount on the balance sheet, depending on how well the business can be expected to service it.
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