Business Valuations - How To Value a Company

Summary

In this Kaplan masterclass on business valuations, Andrew Moer introduces four key methods: asset-based valuations, dividend-based valuations, P/E ratios, and discounted cash flows. He explains each method in simple terms, highlighting the calculation process, advantages, and limitations. The asset-based method focuses on a company's assets and liabilities, while the dividend-based method considers future dividends. P/E ratios rely on comparing similar companies, and discounted cash flow looks at future cash flows and growth potential. Moer emphasizes the importance of understanding these methods for accurate business valuation and their relevance in exams.

Takeaways

• 😀 Asset-based valuation calculates a company’s worth based on its assets minus liabilities, useful for asset-heavy businesses or loss-making companies.
• 😀 Dividend valuation models use dividends to calculate a company's worth by dividing expected dividends by the difference between the cost of equity and growth rate.
• 😀 PE ratio valuation multiplies a company's earnings by an appropriate price-to-earnings ratio, often taken from similar companies.
• 😀 Discounted cash flow (DCF) valuation calculates the present value of a company's future cash flows, providing the most detailed valuation method.
• 😀 The asset-based valuation method may undervalue companies with significant intangible assets or future growth potential.
• 😀 Dividend valuation works best for established companies paying regular dividends but may not be applicable for businesses with no dividends.
• 😀 The PE ratio method is simple and widely used but has limitations, particularly when comparing companies with different growth rates or profit potentials.
• 😀 DCF is highly sensitive to assumptions, such as future cash flows, discount rates, and growth rates, which can significantly impact its results.
• 😀 Each valuation method has its strengths and weaknesses, and the choice of method depends on the type of company being valued.
• 😀 A small change in assumptions, such as the discount rate or growth rate, can significantly affect the valuation outcome, particularly in the DCF model.
• 😀 Valuation methods are often featured in exams, where students are asked to evaluate their advantages and disadvantages to test their understanding of each method.

Q & A

What are the four main business valuation methods covered in the session?

The four main business valuation methods covered in the session are asset-based valuations, dividend-based valuations (using the dividend valuation model), price-to-earnings (PE) ratios, and discounted cash flows.

How do you calculate a company’s value using asset-based valuations?

In asset-based valuations, the value of a company is calculated by subtracting its liabilities from its assets. The assets can be valued using book values, net realizable value, or replacement cost.

What is the net realizable value in asset-based valuations?

Net realizable value refers to the amount a company would receive if it were to sell off all its assets. This value is often considered the minimum price the company would accept in a sale or negotiation.

What is a major disadvantage of asset-based valuations?

A major disadvantage of asset-based valuations is that it ignores intangible assets like brand value, customer base, and company reputation, and it does not account for future growth potential.

What does the dividend valuation model (DVM) assume about the company's future?

The dividend valuation model assumes that a company’s value is based on all the dividends it will ever pay out in the future, growing at a constant rate. It views dividends as a perpetuity growing at a constant rate.

What is a key assumption in the dividend valuation model that could be a limitation?

A key assumption in the dividend valuation model is that dividends will grow at a constant rate forever. This assumption may not hold true, as companies may experience years with no dividends or even reduced dividends.

How is the price-to-earnings (PE) ratio used in business valuation?

In the PE ratio method, the value of a company is calculated by multiplying a suitable PE ratio by the company's earnings. This ratio can be borrowed from a similar company or an industry average.

What is the limitation of using a PE ratio from a similar company for valuation?

The limitation is that the PE ratio is borrowed from another company, which may have a different risk profile, capital structure, or other factors, making the comparison less accurate.

How does the discounted cash flow (DCF) method work?

The discounted cash flow method values a company based on the present value of its expected future cash flows. These cash flows are discounted back to the present using an appropriate discount rate.

What are the advantages of the discounted cash flow method?

The discounted cash flow method is highly detailed, accounts for forecasted growth, and uses cash flows, which are more factual and reliable than profits. It is considered the most accurate and thorough method for valuing a business.

What are some disadvantages of the discounted cash flow method?

Disadvantages of the DCF method include its reliance on uncertain forecasts, the complexity of the calculations, and its sensitivity to changes in assumptions, particularly the cost of capital or equity, which can significantly affect the valuation.