Valuation Methods
Summary
TLDRThis script delves into the three primary methods of business valuation: the cost approach, which considers initial and replacement costs; the market approach, using comparable companies and precedent transactions; and the discounted cash flow (DCF) analysis, an intrinsic valuation forecasting future performance and discounting it to present value. The focus is on understanding these methods to estimate a company's value, highlighting the importance of considering a range of valuations to determine the most accurate business worth.
Takeaways
- 📊 There are three main approaches to professional business valuation: cost approach, market approach, and discounted cash flow analysis.
- 🏭 The cost approach considers both the original cost to build an asset and its current replacement cost, accounting for inflation and technological changes.
- 🔍 The market approach uses relative valuation, comparing the company to similar publicly traded companies or past mergers and acquisitions.
- 📈 In the market approach, valuation ratios such as revenue, EBIT or earnings can be used to estimate the value of the company being assessed.
- 💰 Precedent transactions include takeover premiums, reflecting the higher price paid for control in acquisitions.
- 🔮 Discounted cash flow (DCF) analysis is an intrinsic valuation method that forecasts a company's future performance and discounts it back to present value using a discount rate.
- ⏳ DCF analysis typically projects a company's cash flows for about five years and then applies a terminal value based on perpetual growth.
- 💼 The weighted average cost of capital is commonly used as the discount rate in DCF analysis to determine the net present value of a business.
- 📊 A football field chart is a visual tool used by finance professionals to summarize and compare different valuation methods and stock prices over time.
- 📉 The chart includes relative valuation techniques like comps and precedent transactions, intrinsic value ranges from DCF, and the 52-week high and low stock prices.
- 🤔 The role of a valuation analyst is to weigh different valuation methods, consider a range of values, and determine the most reasonable business value within that range.
Q & A
What are the three main approaches to professional business valuation mentioned in the script?
-The three main approaches to professional business valuation are the cost approach, the market approach, and the discounted cash flow (DCF) analysis.
What are the two methods used in the cost approach for business valuation?
-The two methods used in the cost approach are the original cost to build something and the replacement cost, which takes into account inflation and changes in technology.
How does the cost approach serve as an opportunity cost in business valuation?
-The cost approach serves as an opportunity cost by allowing a potential acquirer to compare the cost of building a similar business from scratch versus acquiring an already operating business.
What is the market approach in business valuation and how does it work?
-The market approach is a form of relative valuation that involves comparing the business being valued with other companies or assets. It uses comparable companies and precedent transactions to determine the value of the business based on market data.
How are comparable companies used in the market approach for business valuation?
-Comparable companies are publicly traded companies that are similar to the one being valued. Their share prices and various financial ratios are used to estimate the value of the business being evaluated.
What are precedent transactions and how do they factor into the market approach?
-Precedent transactions refer to past mergers and acquisitions. They are used to understand how much an acquiring company paid for a business, including any takeover premiums, to help determine the value of the business being evaluated.
What is the discounted cash flow (DCF) analysis and why is it considered an intrinsic form of evaluation?
-The discounted cash flow analysis is an intrinsic form of evaluation that forecasts the future performance of a business and discounts those cash flows back to the present value using a discount rate, typically the weighted average cost of capital. It focuses on the company's internal performance rather than external market conditions.
How does the terminal value in DCF analysis contribute to the overall valuation?
-The terminal value in DCF analysis represents the value of the business beyond the forecast period, often assuming a sale or perpetual growth rate. It is an important component as it captures the long-term value of the business.
What is the purpose of using a football field chart in summarizing business valuation methods?
-A football field chart is used to visually summarize and compare different valuation methods, providing a comprehensive overview of the value ranges derived from each method, and helping analysts to triangulate and determine a reasonable value for the business.
How do valuation professionals use the information from a football field chart to determine the business's value?
-Valuation professionals review the ranges of values derived from comparable company analysis, precedent transactions, and DCF analysis. They weigh the different methods, consider the upside and downside scenarios, and use their expertise to estimate where the actual value of the business lies within the range.
What is the significance of the 52-week high and low trading prices on a football field chart?
-The 52-week high and low trading prices on a football field chart represent the market's observed valuation of a publicly traded company over the past year. These prices provide context and a reference point for the valuation analyst to compare with the intrinsic and relative valuation methods.
Outlines
📈 Valuation Approaches Overview
This paragraph introduces three primary methods for professional business valuation: the cost approach, market approach, and discounted cash flow (DCF) analysis. The cost approach involves evaluating the initial or replacement cost of an asset. The market approach compares the target company with similar publicly traded companies or past mergers and acquisitions. DCF analysis projects the company's future cash flows, applies a terminal value, and discounts them to present value. The paragraph emphasizes the importance of these methods in corporate finance and introduces a football field chart used by finance professionals to summarize valuation findings.
🔍 Triangulation in Business Valuation
The second paragraph discusses the process of triangulation in valuation, where an analyst must consider various valuation methods—comparable company analysis, DCF with its upside and downside scenarios—to establish a range of possible values. The goal is not to pinpoint a single value but to determine a sensible range and then use professional judgment to estimate the actual value of the business within that range. This approach acknowledges the complexity and subjectivity inherent in valuation.
Mindmap
Keywords
💡Business Valuation
💡Cost Approach
💡Market Approach
💡Discounted Cash Flow (DCF) Analysis
💡Comparable Companies
💡Precedent Transactions
💡Intrinsic Value
💡Net Present Value (NPV)
💡Weighted Average Cost of Capital (WACC)
💡Triangulation
💡Football Field Chart
Highlights
Introduction to three main approaches in professional business valuation: cost approach, market approach, and discounted cash flow analysis.
Explanation of the cost approach, including the original cost and replacement cost methods.
The cost approach's utility in valuation as an opportunity cost for potential acquirers.
Market approach as a form of relative valuation, comparing similar companies or assets.
Use of publicly traded comparable companies for valuation through market approach.
Valuation ratios to determine a company's worth based on revenue, EBIT, earnings, or other metrics.
Precedent transactions as a method to value a company based on past mergers and acquisitions.
Inclusion of takeover premiums in precedent transactions for control positions.
Discounted cash flow analysis as an intrinsic form of valuation, focusing on the company's future performance.
Forecasting the business's performance for about five years in discounted cash flow analysis.
Assumption of a sale or perpetual growth rate to determine terminal value in DCF analysis.
Discounting future cash flows to present value using the weighted average cost of capital.
Focus on public company comparables, precedent transactions, and discounted cash flow analysis in corporate finance.
Use of a football field chart by professionals to summarize valuation methods and stock performance.
Relative valuation techniques represented by comparable company analysis and precedent transactions.
Intrinsic value ranges represented by different DCF valuation cases.
Observation of a company's 52-week high and low trading prices for publicly traded stocks.
The role of a valuation analyst in weighing different methods and determining a range of values.
The art of deciding the actual value of a business within a range of values.
Transcripts
at the end of the day when it comes to
professional business valuation there
are really three main approaches we're
gonna go through each of those three
with you right now
so working from left to right we've got
a cost approach then you've got a form
of relative valuation known as a market
approach and finally you've got an
intrinsic form evaluation known as a
discounted cash flow analysis when it
comes to the cost approach there are two
different methods one is looking at what
the cost to build something was for
example say you were gonna buy a company
that had a manufacturing facility how
much has been invested in building that
facility and what was the total cost of
it another approach is to look at the
replacement cost it's one thing to look
at how much it cost to build something
but that may have been a long time ago
and inflation as well as changes in
technology may mean that the replacement
cost today is dramatically different
than what the cost to build originally
was when looking at valuation the cost
approach can be useful because it's sort
of like an opportunity cost if I was
looking to acquire a company I could
just pay for that business that's
already operating or build it myself
let's look at the market approach a form
of relative valuation with this approach
we look at what other companies or other
assets are worth and used them as a
proxy for what we're trying to value the
first method is to look at comparable
companies that are publicly traded
they're relatively easy to find because
these companies shares trade on exchange
they're publicly invested so it can view
their price at any time and then we can
determine what other investors are
willing to pay for that company if
they're similar to the one we're trying
to value then we can use ratios to
figure out what that company we're
trying to value is worth based on its
revenue or its ebody or its earnings or
some metric like that the other way to
use the market approach
is to look at precedent transactions
precedent transactions mean past mergers
and acquisitions where we can see how
much an acquiring company paid for a
business
this form of valuation includes a
takeover premium so generally more money
is paid for a control position taken
together these two forms of market
valuation can provide a good overview of
what a company might be worth relative
to other companies and then finally on
the right here we have discounted cash
flow analysis which is a form of
intrinsic value intrinsic value means
that we look at the company in isolation
we don't look at what other companies
are worth we don't look at the cost
approach to see how much has already
been invested instead what we do is we
forecast the future performance of the
business out typically about five years
then assume a sale of the company or a
perpetual growth rate to give us a
terminal value this constitutes the
forecast that forecast is then
discounted back to today using a
discount rate typically the weighted
average cost of capital then that lets
us arrive at the net present value of
the business so as you can see this form
of valuation only looks internally at
the company makes assumptions about what
the future of the company will look like
and discounts all of those cash flows
back to today in this course we're gonna
focus on the three main types of
valuation that are most common in
corporate finance those include public
company comparables precedent
transactions and discounted cash flow
analysis here's a football field chart
this is often created by investment
banking corporate development and equity
research professionals when summarizing
the evaluation methods that they've used
to come up with a value for a business
so as you can see across the bottom axis
of this chart there are several
different valuation methods used
comparable company analysis which is
comps precedent transact
discounted cash flow with two different
cases and the current trading price of
the stock over a year with its 52-week
high and low so we've labeled the two
methods on the left as being the
relative valuation techniques the two
DCF valuation cases represent the
intrinsic value ranges for this company
and on the far right side of the graph
we have the 52-week high and low trading
prices of the stock this is observed for
a publicly traded company now the job of
a valuation analyst or professional is
to step back and look at this and weigh
the different methods the comps the DCF
the upside and the downside and
triangulate on some type of value that
they think makes the most sense so it's
not just about arriving at one number
it's about arriving at a range of values
and then the art of deciding where
within that range of values you believe
the actual value of this business lies
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