Earnings Power Value (EPV) is a method of valuing a company's stock based on its current cost of capital and adjusted earnings. EPV is used to analyse a firm's current financial portfolio and identify whether a share is undervalued, overvalued, or fair-valued relative to the market capitalization. The EPV method of stock valuation is often used by corporate finance professionals and investment bankers to determine the ‘real’ value of companies.

In order to calculate Earnings Power Value (EPV), the formula requires two components; the firm's weighted average cost of capital and its adjusted earnings. The weighted average cost of capital (WACC) is a blend of a company’s equity and debt investors’ expected returns, weighted by their respective component proportions. Generally speaking, WACC mirrors the average return that shareholders and other customers require in order to invest in the company. It is calculated as the sum of a company’s cost of equity and the after-tax cost of debt, multiplied by its relative weight to the company’s borrowed risk and capital structure.

Adjusted earnings on the other hand, are calculated as net earnings after taxes and non-recurring items plus corporate cash taxes. This is added to capital expenditure and depreciation to account for the fluctuations in the firm’s earning capacity over time. This calculation provides a clearer insight into what investors could expect from the company over the long-term, without being distorted by one-time or non-cash expenses.

Once both components are calculated, the EPV of a company can be determined by dividing the adjusted earnings by its weighted average cost of capital. Armed with this information, analysts can then compare the EPV equity to the current market capitalization of the company to get an accurate idea of the ‘true’ value of the company. If the EPV of the company is greater than its market capitalization then the company is deemed as undervalued, whilst if the EPV of the company is lower than its market capitalization then the company is considered to be over-valued.

It’s important to note that EPV ignores some important financial aspects, such as future growth and competitor assets. Additionally, the calculation of adjusted earnings is subject to many judgement calls, making calculation of EPV prone to errors. However, when used properly, EPV can provide a valuable insight into a company’s current financial portfolio and is a useful tool for investors when evaluating investments.