Methodology — How We Calculate Fair Value, Risk Scores, and Moat Ratings
Every number on FairValueLabs is calculated from public data using documented formulas. This page explains exactly how — so you can verify our work or adjust the assumptions to match your own investment thesis.
How Do We Calculate the Altman Z-Score?
The Altman Z-Score was developed by Edward Altman at NYU in 1968. It combines five financial ratios into a single score that predicts bankruptcy probability within 2 years. The formula for manufacturing firms:
Z = 1.2(A) + 1.4(B) + 3.3(C) + 0.6(D) + 1.0(E)
| Variable | Formula | What It Measures |
|---|---|---|
| A | Working Capital / Total Assets | Short-term liquidity |
| B | Retained Earnings / Total Assets | Cumulative profitability |
| C | EBIT / Total Assets | Operating efficiency |
| D | Market Cap / Total Liabilities | Solvency buffer |
| E | Revenue / Total Assets | Asset turnover |
How Do We Interpret the Score?
- Z < 1.8 — Distress Zone (red). High probability of financial distress within 2 years.
- Z 1.8 - 3.0 — Gray Zone (yellow). Elevated uncertainty — warrants closer scrutiny.
- Z > 3.0 — Safe Zone (green). Financially healthy by this metric.
We use the original manufacturing formula for industrial companies and Altman's modified Z''-Score for service and financial firms.
Data source: All five inputs are extracted from the company's most recent 10-K annual filing on SEC EDGAR.
How Do We Calculate Intrinsic Value (DCF)?
We use a two-stage Discounted Cash Flow model:
- Stage 1 (Years 1-10): Project free cash flow using the company's historical FCF growth rate (median of last 5-10 years).
- Stage 2 (Terminal Value): Assume growth converges to the long-term GDP growth rate (currently ~2.5%).
- Discount Rate: We use WACC (Weighted Average Cost of Capital) with a floor of 10% for conservatism.
- Margin of Safety: MoS = (Intrinsic Value - Market Price) / Intrinsic Value. Positive = potentially undervalued.
What Are the Key Assumptions?
- Growth rate is capped at 20% to prevent unrealistic projections
- Companies with negative FCF get a zero or negative intrinsic value (honest, not flattering)
- Risk-free rate pulled from FRED (10-year Treasury yield)
- We show a sensitivity table so you can plug in your own growth assumptions
Data source: Historical free cash flow from 10-K/10-Q filings on SEC EDGAR. Current price from Yahoo Finance.
How Do We Rate Competitive Moats?
Our moat rating combines quantitative signals with structured qualitative assessment:
| Factor | Weight | How We Measure |
|---|---|---|
| ROIC Stability | 40% | Standard deviation of Return on Invested Capital over 10 years. Lower variance = wider moat. |
| Gross Margin Trend | 30% | 10-year gross margin trajectory. Expanding margins suggest pricing power. |
| Switching Cost Assessment | 30% | Qualitative: customer lock-in, ecosystem effects, regulatory barriers. |
Star Rating Scale
- 5 stars — Wide moat. Dominant competitive position with high barriers to entry.
- 4 stars — Solid moat. Strong advantages but with some competitive pressure.
- 3 stars — Narrow moat. Some competitive advantages but vulnerable to disruption.
- 2 stars — Weak moat. Commoditized business with limited pricing power.
- 1 star — No moat. Highly competitive, no sustainable advantage evident.
How Do We Grade Dividend Safety?
Our dividend safety grade (A through F) is based on three factors:
| Factor | Safe Signal | Danger Signal |
|---|---|---|
| Payout Ratio | < 60% of earnings | > 100% (paying more than earned) |
| FCF Coverage | FCF > 1.5x dividend | Negative FCF for 2+ quarters |
| Growth Streak | 5+ years consecutive increases | Recent cut or freeze |
Grade Definitions
- A — Very Safe. Low payout ratio, strong FCF coverage, long growth streak.
- B — Safe. Healthy payout with adequate cash flow support.
- C — Borderline. Elevated payout ratio or inconsistent FCF.
- D — Unsafe. Payout exceeds earnings or FCF is negative.
- F — Cut Likely. Multiple danger signals — dividend cut appears imminent.
Data source: Dividend per share, earnings, and free cash flow from SEC EDGAR and Yahoo Finance.
What Are the Limitations?
- All models use historical data — they cannot predict future management decisions, black swan events, or macroeconomic shifts.
- DCF is highly sensitive to growth rate assumptions. Always check the sensitivity table.
- The Altman Z-Score was designed for manufacturing firms. We use modified versions for other sectors, but accuracy varies.
- Moat assessment includes subjective elements. Our rating is a starting point, not a final verdict.
- Quarterly data may lag by 1-2 months after the filing deadline.
This is not financial advice. All data is sourced from SEC EDGAR public filings. Always consult a qualified financial advisor before making investment decisions.