Earnings Power Value (EPV)
Contents
Understanding Earnings Power Value (EPV) in Stock Valuation
Earnings power value (EPV) is a valuation method that assesses a company's current earnings sustainability and cost of capital, excluding future growth projections. Learn how EPV is calculated, its significance, and its limitations.
Explaining Earnings Power Value (EPV)
Earnings power value (EPV) provides insight into a company's current financial standing by evaluating its adjusted earnings against its weighted average cost of capital (WACC). While the formula is straightforward, determining adjusted earnings and WACC involves several steps, resulting in EPV equity, which can be compared to the company's market capitalization.
Formula and Calculation for Earnings Power Value (EPV)
EPV is calculated by dividing adjusted earnings by WACC. Adjusted earnings are derived from operating earnings (EBIT) normalized over a business cycle, adjusted for taxes and excess depreciation. Additional adjustments are made for unconsolidated subsidiaries, restructuring charges, and pricing power. EPV business operations are then determined by dividing adjusted earnings by WACC. Finally, EPV equity is calculated by adding excess net assets and subtracting debt.
Interpreting Earnings Power Value
EPV indicates whether a company's shares are undervalued or overvalued based on its distributable cash flows derived from current earnings. Developed by Professor Bruce Greenwald, EPV overcomes the limitations of discounted cash flow (DCF) analysis by focusing on reliable, current earnings rather than future projections.
Drawbacks of Earnings Power Value
EPV assumes constant business conditions and does not account for fluctuations or unforeseen events that may impact production rates or market dynamics.