Valuation: Approaches and Techniques

 Valuation

What is Valuation?

Valuation is a process of assessing of estimated or intrinsic value of an asset, company, investment, or any financial instrument based on various factors, data, and methodologies. It is an essential part of finance and investment-making decisions. It helps investors and businesses identify the potential value and risk involved in their investment.

 

Where Do we Use valuations?

·         Mergers and Acquisition 

·         Leveraged Buyouts

·         Initial Public Offerings (IPOs)

·         Business restructuring

·         Private Equity Investments

·         Equity Research

 

What are different corporate valuation approaches?

·         Income/Earnings Approach: This approach uses the expected income to measure the free cash flow (FCF) of the company, to measure its value. It can be calculated either by using the FCF or Equity Cash flow and discounting it. This method is also referred to as the DCF method.

·         Economic Approach: This approach uses the Economic profit of a company. Under this approach, value is defined as the sum of the present capital employed and the present value of the projected economic profit for the future.

·         Other Approaches: This includes Relative Valuations in which different market multiples are used which are either trading multiples or previous transaction multiples; Asset-based valuation in which the value of existing assets is a basis for valuations.

 

What are some different valuation techniques?

·         Trading comparable Analysis: In this technique, the worth of a business is estimated by current trading multiples of similar publicly traded companies. This technique comes under the Relative valuation approach. The base of valuations depends upon the current valuation ratios of similar companies. The trading multiples that are used in this technique are EV/EBITDA, P/CF, and Price/Earnings. It is a very simple technique which turns out to be very advantageous as the data is available to the public and easily obtainable.

·         Transaction comparable Analysis: In this technique value of an asset, company, or any financial instrument is assessed based on prices at which similar have recently changed hands in the market. Amount paid for comparable companies or an asset involved in a recent transaction gives an estimate of the real market value of the target asset or company. The data used in this method indicates the real-time value while other valuation techniques may depend upon forecasts and assumptions.

·         Discounted Cash Flow (DCF): When we make forecasts and assumptions for future cash flows it is necessary to factor in the time value of money which means a Dollar made tomorrow is worth less than a dollar today, so to give that effect this technique is used to calculate the present value of the company. Learn more about it here.

 

What view does each technique give?

·         Trading comparable Analysis: It looks for the valuation of a similar publicly traded company and hence provides a market view of the company

·         Transaction comparable Analysis: It looks at the valuation of similar peer companies in recent transactions which helps in getting a hold of the Buyer’s perspective.

·         Discounted Cash Flow (DCF): In this technique, a company’s model is made with forecasts and assumptions which shows how we as an analyst look at the company.