Lesson 3 of 6
Book value plus what is left
Value a company as the equity already on the balance sheet plus the present value of the earnings above the charge. Computed once, by hand, on filed figures.
By Javier Sanz
Founder of ValueScreener. Built Ninety Nine, a securities services provider, and sold it to a tier-one global bank; ran operations and internationalization at Alpaca, the brokerage API.
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In one minute
- The valuation is book value today plus the present value of every future year's residual income.
- Book value is filed and needs no forecast, so the forecasting is confined to the part above the charge.
- How long you let residual income last decides most of the answer, and nothing in the accounts decides it for you.
The model has two parts and only one of them has to be guessed. The first is the equity already on the balance sheet. The second is the present value of what the company will earn above the charge on that equity. Add them and you have a value for the equity.
Two parts of one valuation, on a five-year fade
- Book value at 31 December 202532,169$m
- Present value of five years of residual income44,395$m
- Total on these assumptions76,564$m
The formula
Nothing in that line is controversial. The argument is entirely about the second term, and specifically about how many years of residual income you are willing to write down.
Doing it once, by hand
A five-year version on filed figures
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Take book value at the end of fiscal 2025: 32,169 million dollars.
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Take residual income for fiscal 2025 from the previous lesson: 11,119 million dollars at an 8 percent cost of equity.
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Assume it simply repeats, flat, for five years and then stops. That assumption is the whole model and it is yours, not the filing's.
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Discount five equal amounts at 8 percent. The five-year annuity factor is 3.993, so the present value is 11,119 multiplied by 3.993, or 44,395.
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Add the two parts: 32,169 plus 44,395 is 76,564 million dollars.
The assumption doing the work
Change one thing, the number of years, and watch the answer move. Nothing else in the model changes.
Where the honesty is
A discounted cash flow puts the guessing into the cash flow. This model puts it into the duration of an advantage. Neither removes it. What this model does buy you is a large, filed, unarguable first term: for the company above, book value is 32,169 million dollars whatever anyone thinks about the future.
That matters more for a company whose book value is a large share of its market value, which is the subject of the last lesson in this course. For a company where book is a small fraction, as here, the anchored part is small and the forecast carries nearly all of the weight.
There is a second reason to prefer this shape to a cash flow model, and it is practical rather than theoretical. An error in the terminal assumption of a discounted cash flow moves the whole answer, because the terminal value is usually most of it. Here the first term cannot move at all: whatever you decide about the future, 32,169 million dollars of equity is on the balance sheet on the date the filing was signed. The error you can make is bounded by the size of the second term, and you can see that size before you argue about it.
The charge deserves the same treatment as the horizon. Raise the cost of equity and two things happen at once: the yearly residual income falls because the charge is larger, and the discount factor applied to it falls as well. The two effects push the same way, which is why this model is more sensitive to the cost of equity than a first look suggests, and why stating the rate beside the answer is not a formality.
Check yourself
Which part of this valuation needs no forecast?
- Book value today, which is on the balance sheet
- The residual income stream
- The cost of equity
Show the answer
Answer: A.
Book value is filed. The stream above the charge and the rate used to discount it are both chosen by the person doing the work.On the filed figures above, extending the residual income stream from five years to twenty changes the total from 76,564 to what?
- 106,778
- 141,335
- 171,157
Show the answer
Answer: B.
The twenty-year annuity factor at 8 percent is 9.818, giving a present value of 109,166, which added to book value of 32,169 gives 141,335 million dollars.What does this model do with the uncertainty a discounted cash flow puts into its cash flow forecast?
- It removes it
- It moves it into how long residual income is assumed to last
- It hides it in the book value
Show the answer
Answer: B.
The uncertainty does not disappear. It concentrates in the duration and size of the stream above the charge, which is where a reader should argue with the model.Sources
- The Coca-Cola Company, Form 10-K for fiscal 2025, filed 2026-02-20, accession 0001628280-26-010047. Book value and net income read from the SEC XBRL company facts API on 2026-09-13.
- The company catalogue published by this site, built 2026-09-16 from prices last stored on 2026-09-15, for the market capitalisation quoted.
- Penman, Financial Statement Analysis and Security Valuation, on valuation as book value plus discounted residual earnings.
What this leaves out
- Every horizon in the table is a choice made for this page. No filing says how long a company's returns above the cost of equity last.
- The stream is held flat for simplicity. A real application fades it, and the fade is another assumption.
- The market capitalisation is a stored figure with the date shown, not a live quote.
- Nothing here is a valuation of this company, and nothing here is advice about any security.