Valuation Methods

Summary

This 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

00:00

📈 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.

05:00

🔍 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.

Keywords

💡Business Valuation

Business valuation is the process of determining the economic value of a business or company. It's central to the video's theme, as it discusses various methods for evaluating a business's worth. The script outlines three main approaches to valuation, emphasizing that understanding these methods is crucial for professionals in corporate finance.

💡Cost Approach

The cost approach is one of the three main valuation methods discussed in the video. It involves evaluating a business based on the cost to build or replicate its assets. The script mentions two methods under this approach: original cost and replacement cost, illustrating how the cost approach can serve as an opportunity cost for potential acquirers.

💡Market Approach

The market approach is a form of relative valuation that compares a business to others in the market to determine its value. The video explains that this approach uses comparable companies and precedent transactions to establish a benchmark for valuation, highlighting its use in understanding what similar businesses are worth.

💡Discounted Cash Flow (DCF) Analysis

DCF analysis is an intrinsic form of evaluation that focuses on the future cash flows of a business and discounts them to their present value. The script describes how this method forecasts a company's performance over five years and uses a terminal value to estimate its net present value, emphasizing its focus on internal company performance.

💡Comparable Companies

Comparable companies are publicly traded businesses that are similar to the one being valued. The video script uses this term to explain how their market values can be used as a reference point for valuation ratios, such as price-to-revenue or price-to-earnings, to estimate the value of the company in question.

💡Precedent Transactions

Precedent transactions refer to past mergers and acquisitions that can be used as a benchmark for valuation. The script mentions that these transactions often include a takeover premium, which is the additional amount paid for control, and are a key part of the market approach to valuation.

💡Intrinsic Value

Intrinsic value is the perceived real value of a company based on its fundamentals, independent of market prices. The video script explains that DCF analysis calculates intrinsic value by forecasting a company's future cash flows and discounting them back to the present, providing a value that is not influenced by market conditions.

💡Net Present Value (NPV)

Net present value is the difference between the present value of cash inflows and the present value of cash outflows over a period of time. The script describes how NPV is derived from the DCF analysis, representing the total value of a company's future cash flows when discounted back to the present.

💡Weighted Average Cost of Capital (WACC)

WACC is the average rate that a company expects to pay to finance its assets, and it is used as the discount rate in the DCF analysis. The video script explains that WACC is crucial for determining the present value of future cash flows, thus affecting the company's valuation.

💡Triangulation

Triangulation in the context of the video refers to the process of considering multiple valuation methods and arriving at a range of values for a business. The script emphasizes that a valuation analyst must weigh different methods, such as comps and DCF, to determine a reasonable value for the company.

💡Football Field Chart

The football field chart is a visual representation used by professionals to summarize various valuation methods and their outcomes. The script describes how this chart displays different valuation techniques and the stock's trading price over a year, providing a comprehensive view of a company's potential value.

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