Company Risk Factors to Determine Discount Rate and Margin of Safety - L. C. Chong

Posted by L. C. Chong on October 15, 2013

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:

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.

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