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Market-Based Valuation

Market-Based Valuation. Dr Clive Vlieland-Boddy. Valuating of a house. If you had a house you could uses the sale of next door as a reasonable guide of the value of yours. Likewise say a car. But not quite so easy for a business albeit the business is similar and operating in the same city.

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Market-Based Valuation

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  1. Market-Based Valuation Dr Clive Vlieland-Boddy

  2. Valuating of a house • If you had a house you could uses the sale of next door as a reasonable guide of the value of yours. • Likewise say a car. • But not quite so easy for a business albeit the business is similar and operating in the same city.

  3. Valuation Market Multiples 3 • Uses a similar sale as a guide. • Used as a shortcut valuation method • Does not rely on subjective forecasts of future performance • Also referred to as the method of comparables

  4. Main Problems • Few company sales of same type • Information about basis often limited • Yes... Headline value available but not how arrived at. • What basis used? • What multiple employed?

  5. Using the Valuation Model 5 Step 1 Identify companies that are comparable to the target company on relevant dimensions Step 2 Compute the market multiple (Usually P/E) using the average of the market value ratio to the performance measure for each company compared Step 3 Multiply the summary measure by the market multiple to get the target company’s value Step 4 If equity performance, divide by outstanding shares. If company performance, subtract net nonoperating obligations before dividing by outstanding shares Step 5 Select a relevant likely performance measure from financial statements (EBIT or Net Earnings)

  6. Weaknesses of the Market Multiple Model 6 • No ‘right’ measure to use • Because company value depends on future performance which is not known. • No ‘right’ companies to use for comparison • Could be over or undervalued • No ‘right’ way to combine comparable company data to produce a multiple

  7. Using comparable firms-Pros and Cons • The most common approach to estimating the PE ratio for a firm is • to choose a group of comparable firms, • to calculate the average PE ratio for this group and • to subjectively adjust this average for differences between the firm being valued

  8. Problems with this approach • The definition of a 'comparable' firm is essentially a subjective one. • The use of other firms in the industry as the control group is often not a solution because firms within the same industry can have very different business mixes and risk and growth profiles. • There is also plenty of potential for bias. • Even when a legitimate group of comparable firms can be constructed, differences will continue to persist in fundamentals between the firm being valued and this group.

  9. Assessing Quality of Value Estimates 9 • Careful selection of companies • Such as similar capital structures (Debt/Equity) • Operating in the same industry • Similar size and opportunity

  10. Selecting Comparables for Market Multiples 10 • Companies should be selected based on similar profitability, growth, and risk • If possible previous sales are an excellent method of establishing the value. This can be adjusted for differences. • Common multiple is P/E Ratio

  11. PE Ratios in Relation to Profitability, Growth and Risk 11 Consider expected earnings, growth, and risk when selecting comparables to use for valuing a firm based on earnings multiples. • Growth and risk affect PE • Profitability has no effect on PE • Unaffected by RNOA • Expected growth in residual income leads to higher PE ratios • Higher cost of equity capital leads to lower PE ratios

  12. Market-Based Methods:Comparable Transactions’ Method • Most accurate method whenever the transaction is truly comparable and very recent. • Major limitation is that truly comparable transactions are rare.

  13. COMPARABLE MARKET TRANSACTIONS Caveats Few sales with public information Special conditions usually undisclosed Different negotiating skills Distorting effects of varying values Assets not always directly comparable

  14. In Summary ... • The basic value must be the net asset value. This is the absolute minimum that the vendor should accept. • Then establish an earnings valuation. This should be a range based on various subjective issues. • Then test this by using a Market value from a comparable transaction.

  15. In Conclusion • This is a difficult science. • No two persons would arrive at the same figure. • Create a range and establish where in that range you are happy. • In the end it is what a willing buyer will pay and want a willing seller will accept.

  16. The End 16

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