Take a look at this graph where we've plotted the dividends,
the payments to the owners in the corporation Kellogg’s,
against the share market price, the market value of equity.
We see that there's a nice pattern,
whereby Kellogg's has been paying successively higher dividends over time.
It looks like that particular cash flow, the entitlements to
dividends in Kellogg's, has been fairly predictable.
A nice stepwise function over the past 15 years.
And the share price has reflected
that increasing entitlement of the shareholders.
But other cash flows are probably not quite as predictable.
So future sales and expenses for example are uncertain and
they're due to a variety of risk factors that confront every corporation.
The level of competition, the more competitive the market,
the more pressure there will be on prices, and therefore on future sales.
Labor costs, negotiations, with unions.
Raw material prices, the wheat price varies dramatically from season to season.
External factors, health recommendations for example.
Suggesting that cereals might not be good for
your health would have a major impact on those cash flows.
But we don't know at present how that is going to pan out in the future.
And there are other risks.
Risks that are not directly related to the actual business operations of Kellogg's.
But are nonetheless very important for the investor to make the right decision.
Like inflation and opportunity cost.
So, how do we deal with these risk factors?
The corporation-specific risk factors?
The more macro risk factors?
We deal with them in a technology called discounted cash flow valuation, DCF.
It's considered to be the gold standard in finance.
Whereby we provide absolute valuation of an investment opportunity.
We will be looking for intrinsic value
in the cash flows that the corporation is going to generate in the future.
But that valuation technique will still be supplemented by many financial analysts
by other techniques that provide what we label as relative valuation or
multiples valuation.
We've seen some of that when we were discussing financial ratios.