The valuation process

The word 'valuation' implies a precision that's just not possible in the process of guesstimating what a company's shares may be worth. The reality of the task for Bearbull involves using tools of varying complexity to generate valuations that are as useful for examining the assumptions behind them as for the valuation figures themselves. Of course, these being spreadsheet-based applications, the assumptions can be varied at will to see their effect on the outcome. Thus I can play happily with changing costs of capital, base-level profits, rates of capital spending and so forth. The aim is always to address the questions: if I pay xp for a company's shares, are the odds on my side? Can I live comfortably with the possibility of losses? Is there more upside than downside and is the weighted quantity of the upside (amount times probability) far higher than the downside?

The best result - where the valuation is the fattest multiple of the share price (see table) - comes from valuing Zytronic's cash flows. This model attempts not just to put a value on the recurring free cash that a company generates; it also takes the capital spending a company makes to expand its operation - ie, the cap-ex that exceeds the depreciation charge - and values that.

For Zytronic, capital spending is little more than depreciation. This is good to the extent that more free cash can go directly to shareholders; but it's bad as it suggests that Zytronic can't find many profitable investment opportunities and that implies slower growth in the future. That would be disappointing given that touch screens - and certainly those you find in public spaces - are becoming more sophisticated and even more widespread. Yet, for the past two or three years, much of Zytronic's fizz has most likely derived from a deal with Coca-Cola to supply touch panels for Coke's 'Freestyle' drinks dispenser and that may have gone a bit flat.

Anyway, valuing the 18p or so of free cash that Zytronic could be expected to produce in an average year at Bearbull's required rate of return (8.5 per cent), then adding in the value of approaching 5p a year of expansionary capital spending gives a valuation north of 250p per share. Happily, that's consistent with the 'installed value' method, which focuses on likely recurring profits and adds in the benefit of the small amount of tax that Zytronic saves by using some debt in its capital mix.

As to valuing the shares via a dividend discount model, you can often find any figure you want. However, Zytronic's value is hit because falling profits indicate that the dividend won't grow much in the next couple of years. That said, Zytronic's level of capital spending and return on equity indicate that, in the long run, its dividend could grow at a rate that justifies a share price clear of 300p.

Depressed earnings for the year just ended mean that, despite falling 47 per cent from their 2012 high, Zytronic's shares are rated well above their five-year average. That means the 'upside/downside' ratio of how much the share price could rise or fall does not produce a great result. No worries. The check-up to see if its past profits have been real, to ensure that Zytronic has not simply re-cycled new equity and debt into profits - as some companies do - give a clean bill of health.

■ A week ago it seemed odds-on that shares in Juridica (JIL) would go into my income fund. Actually, they won't. At 149p, they trade above net asset value (about 136p) and to pay more than NAV introduces a new - and risky - element. Buy the shares for less than NAV and you would have got the estimated payout to Juridica of all the US legal cases it has helped to fund for less than 100¢ in the dollar. As the case load is mature and Juridica's managers expect big awards during 2014, that should have been good business. But if you buy Juridica's shares today, you have to believe its legal advisers will repeat the trick of identifying likely cases, striking a deal with the plaintiffs and so on. Quite likely they can, but betting on management's expertise is quite different from betting that a portfolio of illiquid investments will eventually realise its estimate of fair value. At many investment companies, management's 'expertise' is one reason why their shares trade below NAV. There is no compelling reason why Juridica should be an exception to that rule.