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VALUATION CONCEPTS - Discussion 1 - Notes 101

Valuation is the analytical process of determining the worth of an asset or company, which is crucial for understanding company assets, resale value, and attracting investors. Various valuation methods exist, including liquidation value, market value, and discounted cash flow, each with its own limitations such as reliance on assumptions and potential bias. Investors should utilize multiple methods to gain a comprehensive understanding of value rather than depending on a single valuation figure.

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4 views9 pages

VALUATION CONCEPTS - Discussion 1 - Notes 101

Valuation is the analytical process of determining the worth of an asset or company, which is crucial for understanding company assets, resale value, and attracting investors. Various valuation methods exist, including liquidation value, market value, and discounted cash flow, each with its own limitations such as reliance on assumptions and potential bias. Investors should utilize multiple methods to gain a comprehensive understanding of value rather than depending on a single valuation figure.

Uploaded by

LJ
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WHAT IS VALUATION?

​ VALUE is the monetary, material, or assessed worth of an asset, good, or service.

​ VALUATION --- The analytical process of determining the current (or projected) worth of an asset or a company.

​ Determine the fair value of a security, which is determined by what a buyer is willing to pay a seller

IMPORTANCE OF VALUATION
A.​ Better knowledge of Company assets
B.​ Comprehending company’s resale value
C.​ Obtain a true company value
D.​ Mergers and Acquisitions
E.​ Access to more investors

A. Better Knowledge of Company Assets


Specific numbers need to be gained from valuation processes so that business owners can obtain proper insurance
coverage, know how much to reinvest into the company, and how much to sell your company for so that you still make a profit.

B. Comprehending Company’s Resale Value


If the management is contemplating to sell the company, knowing its true value is necessary. This process should be started
far before the business goes up for sale on the open market because it will have an opportunity to take more time to increase the
company's value to achieve a higher selling price.
C. Obtain a True Company Value
Knowing the true value of the company is often a deciding factor if selling the business becomes a possibility. It also helps
to show company income and valuation growth over the course of the previous years. Potential buyers like to see that a company
has seen regular, consistent growth as it ages.

D. Mergers and Acquisitions


When a company goes for merger or acquisition, the valuation of business gains substantial significance. As it assist in
determining the value of assets, current scenario of the company’s growth going for merger /acquisition and whether
post-acquisition / merger it possesses growth potential.

E. Access to More Investors


While seeking additional investors to fund company’s growth or save it from financial catastrophe, the investor will demand
for a complete company valuation report. One should also provide potential investors with a valuation projection based upon their
provided funding.

TYPES OF VALUATION
1)​ Liquidation Value (The amount of money realized by selling a firm’s assets and paying off creditors)
2)​ Going concern Value (The value of a firm as an operating business)
3)​ Book Value (The accounting value of a firm or an asset)
4)​ Market Value (The transaction price of the asset in the marketplace)
5)​ Intrinsic Value (The true value of an asset)
VALUATION METHODS

1) Book Value Method


2) Adjusted Net Asset Method
3) Capitalization of Earnings/ Cash Flow Method
4) Discounted Earnings/ Cash Flow Method
5) Dividend Paying Capacity Method

1)​ Book Value Method


(Based on Financial Accounting Concept that OWNER’S EQUITY is determined by Subtracting the book value of a company’s
LIABILITIES from the book value of its Asset.)
(Buy/Sell Agreement)
2)​ Adjusted Net Assets Method
(used to value a business based on the difference between the Fair Market Value of the Business Assets + Liabilities)
(Estimating the Value of a NON-OPERATING BUSINESS)

3)​ Capitalization of Earnings/ Cash Flow Method


(used to value a business based on the FUTURE ESTIMATED BENEFITS, normally using some measure of earnings or cash flows
to be generated by the company)
(Valuing a PROFITABLE Business where the Investor’s INTENT is to provide for a Return ON Investment)

4)​ Discounted Earnings/ Cash Flows Methods

a)​ PV of Annual Cash Flows (Present Value of Projected Future Earnings)


b)​ PV of Terminal Value
​ Terminal Value --- Value of the business after the forecasted period which is the Steady State Period – to infinity
--- a large portion of value; Very Sensitive to Assumptions
(2) Methods of Computing for Terminal Value
●​ Growing Perpetuity Method;
●​ EV Multiple Method

(1)​ Growing Perpetuity Method


(2)​ Exit Value Multiple

​​

(Note (not sure): Get the Average of the TWO)!!!

5)​ Dividend Paying Capacity Method


(This method of valuation is based on the FUTURE Estimated Dividends TO BE PAID OUT or the CAPACITY TO PAY

😉
OUT.)
(Estimating the Value of the businesses that are RELATIVELY LARGE
(and Business that have had a HISTORY of PAYING DIVIDENDS TO SHAREHOLDERS)
LIMITATIONS OF VALUATION
Limitations of Valuation Explained
Valuation is a crucial tool for assessing the worth of a company or stock, but it has several important limitations that investors and
analysts must understand:

1. No Single Best Valuation Method


There are many valuation techniques available, ranging from simple to complex. However, no single method works perfectly
for every company or situation. Each stock and industry has unique traits that may require using multiple methods to get a clearer
picture. This variety can overwhelm investors when choosing which method to use initially.

Example:
A tech startup with no dividends might be poorly valued by dividend-based models but better assessed with discounted
cash flow (DCF) or relative valuation methods. Meanwhile, a mature utility company paying steady dividends is better suited for
dividend discount models.
2. Different Methods Yield Different Values
Because valuation methods rely on different assumptions and data, they often produce different values for the same
company. This can lead to confusion or bias, as analysts might favor the method that shows the company in the best light.

Example:
One analyst using a price-to-earnings (P/E) ratio might value a company at $50 per share, while another using discounted
cash flow might value it at $40 per share. The difference arises from the assumptions about growth rates, discount rates, and market
conditions.

3. Dependence on Assumptions and Estimates


Valuations are not exact calculations but estimates based on assumptions about future cash flows, growth rates, discount
rates, and market conditions. Small changes in these assumptions can significantly affect the valuation outcome.

Example:
In a DCF model, increasing the assumed growth rate by just 1% can raise the valuation by a large margin, while a slight
change in the discount rate can lower it considerably.

4. Complexity and Data Requirements


Some valuation methods, especially absolute models like DCF, require detailed financial data and sophisticated
calculations. This complexity can lead to errors or make the process inaccessible to less-experienced investors.

Example:
A small investor may find it difficult to accurately estimate free cash flows or weighted average cost of capital (WACC),
leading to unreliable valuations.

5. Market and Industry Specific Factors


Valuation models may not fully capture unique industry characteristics, company-specific factors (like management quality
or product innovation), or macroeconomic and regulatory environments.

Example:
A biotech company’s valuation might ignore the potential breakthrough of a new drug if the model only looks at current
financials, missing significant future value.

6. Short-Term Focus of Some Methods


Relative valuation methods often rely on current market data and peer comparisons, which may emphasize short-term
factors and ignore long-term trends or growth potential.

Example:
A company temporarily underperforming due to a market downturn might appear undervalued relative to peers, but the
method may not reflect its strong long-term prospects.

7. Subjectivity and Analyst Bias


Valuation involves subjective judgments, such as choosing which method to use, selecting comparable companies, or
deciding on growth assumptions. Different analysts may reach different conclusions for the same company.

Example:
Two analysts valuing the same stock might disagree on the discount rate or growth projections, leading to different valuation
results.

SUMMARY
Valuation is a valuable but inherently imperfect tool. Its limitations include the lack of a one-size-fits-all method, reliance on
assumptions, complexity, potential bias, and inability to fully capture all company or market nuances. Investors should use multiple
valuation methods and consider a range of values rather than relying on a single figure to make informed decisions

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