Explaining Valuation Theory to My Dad

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Article by Bivek Neupane

A couple of days ago a friend of mine asked me about the so-called “factors” that I keep referring to every now and then. When he asked me that question, I was a bit confused. Not because I didn’t have a detailed understanding of the topic but because he did not have a finance background.

As soon as he asked me that question, I immediately started thinking – What would be the simplest and best possible explanation regarding these risk factors that will not require any sort of preliminary understanding of financial theories?

After thinking for a while, I think I have come up with an answer. I am going to structure this piece like Plato’s dialogue and take the role of Socrates (no, I am not wise like Socrates, but let me have my moment alright!). Also, the other party in this dialogue, my dad is a businessman so he does have a surface-level understanding of things like sources of capital (debt and equity), managing leverage, etc. Hopefully, after having this conversation, he will think about risk and returns in a different way. That being said, let’s start from the very beginning.

Alright, dad, you keep asking me about which stock you should buy next. I will answer all of those questions you have asked me until now altogether in this article. But first tell me, what is a stock? 

Dad: “Ughh..!?”

Let me help you with the definition. A stock is simply the value of a firm’s book value (the assets that the company basically owns like buildings or IPs) + the discounted value of future cash flows.

Dad: “Wait a minute, what the hell is discounted value of future cash flows?”

A very good question. Let me put it this way. You see a company making good profits and you want to take part i


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