3) Things you need to know: valuation

 

Valuation can be performed in many different ways, and the ‘best’ methodology depends on the purpose and perspective of the valuation. If you are valuing a company from the perspective of existing shareholders (equity value), then that is quite different from valuing the full enterprise value in case of a takeover.

In Investment Banking, we primarily look at the full enterprise value, because usually we are looking at scenarios involving a major corporate event which will substantially change the way a company is funded, making the current financing less relevant. In Equity Research, valuation would more commonly be centred around the equity value of the company, as it is the stock market’s perception of this value that (directly) affects the share price and thus shareholder returns.

Intrinsic valuation vs. comparable valuation

What valuation methodologies are there? The main ones are Discounted Cash Flow (“DCF”), and comparable companies analysis. DCF looks at Internal Rates of Return (“IRRs”) or at Net Present Value (“NPV”). Comparable companies analysis looks at trading comparables (“trading comps”) and transaction comparables (“precedents”).

DCF is an intrinsic valuation methodology in the sense that it looks at the standalone value of a company, independent of current market valuation of other similar companies. It simply looks at the cash a company is expected to generate, the risk to the cash a company is expected to generate, and the return demanded by investors for taking on that risk (plus the return for the time value of money as discussed previously). These different methodologies will be discussed in more detail in the next section.

That number is wrong!

Valuation is an art, not a science, and you will find that valuations do move based on ‘soft’ factors. However, as with many good art-forms, good science/mathematics helps! (just ask Da Vinci)

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 Posted by at 11:46 am

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