Basic Questions

[Andrew Sorrells]

Hi! I’m new to CasP (almost done with Chapter 9) and don’t have much of an economics background, so I was hoping to ask some really basic questions.

I’m not sure I’m correctly understanding some basic terminology. First, I’m not sure what “discounting” means as it’s used in the book. I gather it relates to the process of basing the price of an asset on estimations of its future earnings?

Also, what is the difference between “capitalization” as its used here and price/earnings ratios?

Please explain it to me like I’m a very dumb man, because I am a very dumb man.

Topic

[Scot Griffin]

Andrew,

You may find this forum thread helpful.

The most common use of the term “capitalization” in CasP is shorthand for “market capitalization” and refers to the market cap of a company’s stock, which is the price of a single share of the stock multiplied by the total number of outstanding shares. According to CasP theory, a company’s market cap, i.e., capitalization, is a quantification of its relative power to create or change order within society.  Market cap is one of the “key statistics” maintained for every publicly traded company by financial websites like Yahoo Finance.

CasP uses the terms “discounting” and “discount rate” in exactly the same way they are used in finance and accounting.   A company’s market capitalization does not represent the present value of its present assets, it represents the present value of its future earnings (profits).  To determine the present value of future earnings — which are really only estimates based on certain assumptions– you discount them according to a formula using a discount rate. This basic process is known as “net present valuation” or “NPV,” which is readily available as a function in spreadsheet programs.  If you want a deep dive on NPV and how it relates to discounting, see this link.  NOTE: the book simplifies the presentation of discounting and discount rate and does not use the NPV formula, but sometimes it is better to sacrifice detail for clarity.

FYI – as much as the book talks about economics, CasP theory is grounded in finance. So, not having an economics background is to your advantage.

 

[Andrew Sorrells]

Thank you so much for your thoughtful reply! I’m going to do some reading and see if I have any follow up questions.

[Jonathan Nitzan]

Andrew Sorrells wrote:

Also, what is the difference between “capitalization” as its used here and price/earnings ratios?

These are two distinct, albeit connect concepts.

1) P/E ratio = price per share / profit per share = capitalization / overall profit

In CasP:

2) capitalization = expected future profit / (risk x normal rate of return)

Note that P/E relies on current earnings that are known, whereas capitalization discounts expected future earnings that are unknown.

• This reply was modified 2 years, 4 months ago by Jonathan Nitzan.

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