Financial Modeling

  

Categories: Metrics, Accounting, Banking

The process of using existing data to predict how a company or investment is going to behave financially in the future.

In the business news world, we often hear about things like “predicted earnings” and “predicted growth.” We might come across statements like these: “The Wax Candlestick Co. fell short of its predicted sales goals for the quarter, and now its stock is in the toilet.” So...where do these predictions come from? Are they using some kind of crystal ball? Tarot cards? Tea leaves? A Ouija board? Professor Trelawney in the tower?

No, what they’re using is something called financial modeling. A company takes all of its data, all of its numbers, that deal with whatever category of business they’re trying to predict (earnings, growth, sales, revenue, whatevs). Then they look at how those numbers have changed over time, taking care to account for outside influences like new laws, economic changes, interest rate hikes, and the like. Then experts apply their, you know, expertise...to all of that data, and try to predict how those numbers might change over the next month, quarter, year, or beyond. Companies and their investors then use those predictions—those financial models—to guide their business and investment decisions.

Related or Semi-related Video

Finance: What is the Dividend Discount M...2 Views

00:00

Finance allah shmoop what is the dividend discount model Well

00:07

it's a technique used to value companies or at least

00:11

it wass in the stone age And yet in the

00:14

nineteen fifties maybe which basically says that a company's value

00:17

is fully contained in the cash dividends it distributes back

00:22

to invest doors This model is only useful really for

00:25

its historical relevance We we just don't use that much

00:28

these days Yeah back in the old timey cave man

00:30

days when there was essentially no research of real merit

00:33

being done on the performance of investments of whatever flavor

00:37

the dividend discount model was the best thing investors had

00:40

to value an investment in a company And remember in

00:43

those days companies paid rial dividends that were a meaningful

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percentage of the total value of the company Unless so

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a company pays a dollar a share this year in

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dividends Historically it's raised dividends at about three percent a

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year like paid a dollar last you'd expect two dollars

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three next year in dollars six and change the next

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so well The dividend discount model discounts backto present value

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And yes we have an opus on what president value

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Means but here's the logline definition present value of all

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future cash flows discounted for risk in time Back to

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cars Yeah that thing well a few odd things are

01:18

worth noting in this horse and buggy era formula The

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dividend discount model ignores the terminal or end value of

01:25

the company Like say twenty years from now the company

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is sold for cash The dividends are all that are

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really focused on though in our model that seem strange

01:34

to you Well maybe But let's say the discount rate

01:37

is ten percent in the risk free rate is four

01:40

percent for a total of fourteen percent a year discounted

01:43

back to the present So doing the math just looking

01:45

at the terminal value of say a hundred million bucks

01:47

in a sale to be made twenty years from now

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Let's figure out what that's worth today Well you take

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the one point one four Put it to the twentieth

01:54

power to reflect twenty years of discounted valuation compounding And

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you say one point one four forty twenty powers about

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thirteen point seven So to get the present value of

02:04

one hundred million bucks twenty years from now using this

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discount rate Will you divide the hundred million by thirteen

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point seven and that means that the one hundred million

02:13

dollars twenty years from now today is worth only seven

02:16

point three million bucks And yeah that's ah big haircut

02:20

kind of like this guy Well the formula focuses ah

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lot on near term dividend distribution and it's Really more

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interesting is a relic of original financial research in theory

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than anything directly useful today And if you find this

02:33

interesting while then we may have a gig for you

02:36

here at shmoop finance central Yeah come on down We 00:02:39.715 --> [endTime] need writers good ones not like me

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