Valuations Methodology - J Samuel Richards

Valuation of a company is not an exact science and ultimately depends upon what it is worth to a serious investor or buyer who for his or her own reasons may be prepared to pay a substantial goodwill.

This exercise may be carried out using various methodologies, the relative emphasis of each often varying with:

  • Industry to which the company belongs
  • Ease with which the growth rate in cash flows to perpetuity can be estimated
  • Extent to which industry and comparable company information is available
  • Need for an independent fixed asset valuation/ revaluation.

Having arrived at an assessment of fair value, some adjustments that are typically considered in such an exercise are:

Whether there is change of control and therefore a control premium is justified for a particular purchaser, if any.

Whether the shares are marketable and frequently traded or there is a case for discounting on account of illiquidity, if applicable. Our assessment of the valuation of the Company will be on the basic assumption of a going concern entity and would be based on some or all of these popular methodologies:

Net Asset Value Method
The value arrived at under this approach is based on the audited financial statements of the company and may be defined as “Shareholders’ Funds” or net assets owned by the company. The balance sheet values are adjusted for any contingent liabilities that are likely to materialize.

Maintainable Profit Method or Discounted Cash Flows Method
DCF uses the future free cash flows of the company discounted by the firm’s weighted average cost of capital (the average cost of all the capital used in the business, including debt and equity), plus a risk factor measured by beta.

Comparable Company Market Multiple
Market multiples of comparable listed companies are computed and applied to the Company being valued to arrive at a multiple based valuation.

Price/Earnings multiple
This is a popular method due to its simplicity. Earnings before interest, depreciation and tax is usually preferred over net earnings in order to even out differences caused by capital structure, tax benefits, etc.

Market Cap/Sales Multiple
This method is sometimes used to value the SME sector by multiplying a year’s gross/net profit or sales by a certain number, determined as the appropriate multiple for the type of business.

Industry Valuation Benchmarks
A number of industries have industry-specific valuation benchmarks such as ‘EV per MW’ for power generation companies, ‘EV per subscriber’ for telecom companies, etc. which can be applied as rule of thumb for business valuation.