Valuation of a company's stock can be based on the expected dividends. However, growing companies generally prefer to plough back their income into their business for future expansion, instead of shelling out dividends to their investors. Using Dividend Discounting Method for valuing such companies will therefore be difficult.

The value of growing companies that do not pay dividends can be determined using the Capitalization of Earnings method. That is, simply dividing the earnings that are expected one year ahead by a capitalization rate. Capitalization rate is the discount rate adjusted for growth rate (.i.e. Capitalization rate = Discount rate less Expected Growth rate). It can also be WACC (Weighted Average Cost of Capital). Capitalization rate represents the risk associated with the business to be valued.

Earnings used in the calculation are EBIT (Earnings before Interest and Tax) which are adjusted for non-recurring income and expenses. Adjusting one time items is important to arrive at a realistic valuation and avoid making wrong investment decisions. Please note that discounting EBIT will give you the value of the whole business. To determine the value for equity holders, you will have to subtract the value of debt from this value.

Also remember that value arrived by capitalizing earnings will depend on the strength of assumptions made about expected earnings and long term growth rate. Several estimates and projections go in determining the future growth rate of a business. The shortcoming of this method is that one cannot value companies that generate negative earnings.

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