Amazon is the company I chose for the project, and the valuation method I will
use is discounted cash flow. This method can be used to calculate a company's
intrinsic value by projecting future cash flows and then discounting them to
today's value. In addition, because Amazon has pursued a strategy of
reinvesting most of its profits back into the business, this method will assist in
determining the value of an investment today based on projections of how
much money it will generate in the future (Fernando, 2022).
To evaluate Amazon.com, Inc, I would choose the residual income valuation
approach, also known as the residual income model or residual income method.
It “is an equity valuation method that is based on the idea that the value of a
company’s stock equals the present value of future residual incomes
discounted at the appropriate cost of equity” (Corporate Finance Institute,
2019, May 6). Residual income valuation assumes that the true “cost of capital”
accounts for earnings generated by a company. This method of valuation uses
the data that is readily available on the financial statements and looks at
economic profitability rather than accounting profitability.
This fits Amazon because in general, residual income valuation is for mature
companies that do not give dividends. Using the projected income statement,
the growth will be estimated using the past years, however, we may need to go
further back than the pandemic to get a more accurate valuation. Pushing aside
the outliers of the spike in growth due to the pandemic, I will be able to
calculate the average growth and apply it to the equation. Residual income
equals net income less equity capital multiplied by cost of equity.
References
Corporate Finance Institute. (2019, May 6). Residual income valuation.
Retrieved August 2, 2022, from
https://corporatefinanceinstitute.com/resources/knowledge/valuation/residu
al-income-valuation/
Fernando, J. (2022, June 3). Discounted Cash Flow (DCF). Investopedia.
https://www.investopedia.com/terms/d/dcf.asp
