The capitalized earnings method consists of calculating the value of a company by discounting future profits with a capitalization rate adjusted to the determining date for the valuation.
In the context of the capitalized earnings method, a company is considered as an investment. Attention is therefore focused solely on the future profits that the company will make, on the associated risks or on earnings projections. Operating assets are seen only as a way of making profits and no specific value is allocated to these.
To calculate capitalized earnings, the company’s profits are estimated for the following two to five years from the valuation date. It is important to point out that this refers to adjusted profits. Extraordinary and non-operating income and expenses, along with salaries not conforming to the market, must be adjusted. Adjusted operating profits are discounted using a capitalization rate corresponding to an earnings projection adapted to the risk of this specific company. If the company has assets not essential to operation (e.g. real estate outside the company or surplus liquidities), these will be calculated separately, then added to the capitalized earnings calculated.
If we set aside detailed planning for future financial years, we can proceed with a simplified calculation of capitalized earnings. To do this, long-term operating profit is estimated, then discounted with the capitalization rate:
