The Purpose Of Valuation Flashcards
What’s the point of valuation?
You value a company to determine its Implied Value according to your views of it.
Public companies already have market caps and share prices. Why do we value them?
Market Cap and Share Price reflect its current value according to “the market” - but the market might be wrong.
You value companies to see if the market’s views are correct or incorrect.
What are the advantages and disadvantages of Public Comps?
Advantage: They are based on real market data, are quick to calculate and explain, and are less subject to far-in-the-future assumptions
Disadvantage: There may not be true comparable companies, the analysis will be less accurate for volatile or thinly traded companies, and it may undervalue companies’ long-term potential.
What are the advantages and disadvantages of Precedent Transactions?
Advantage: They are based on real prices that companies have paid for other companies, and they may reflect industry trends more than public comps.
Disadvantage: The data is often spotty and misleading, there may not be comparable transactions, and specific deal terms and market conditions might distort the multiples.
Which of the 3 main methodologies will produce the highest Implied Value?
This is a trick question because almost any methodology could produce the highest Implied Values depending on the industry, time period, and assumptions.
Precedent Transactions generally produce higher Implied Values than Public Comps because of the control premium - the extra amount that acquirers must pay to acquire sellers.
When is a DCF more useful than Public Comps or Precedent Transactions?
You should pretty much always build a DCF since it IS valuation - the other methodologies are supplemental.
But it’s especially useful when the company you’re valuing is mature and has stable, predictable cash flows, or when you lack good public comps and precedent transactions
When are Public Comps or Precedent Transactions more useful than DCF?
IF the company you’re valuing is early stage, and it is impossible to estimate its future cash flows or the company has no path to cash flow at all, you have to rely on these other methodologies.
Which should be worth more: A $500 million EBITDA healthcare company or a $500 million EBITDA industrials company?
Assume the growth rates, margin, and all other financial stats are the same.
In all likelihood, the healthcare company will be worth more because healthcare is a less asset-intensive industry.
This means the company’s CapEx and Working Capital requirements will be lower, and Free Cash Flow will be higher as a result.
Healthcare tends to be more of a “growth industry” than industrials.
How do you value an apple tree?
The same way you value a company: Com parables and a DCF. You’d look at what similar apple trees have sold for, and then calculate the expected future cash flows from the apples the tree produces.
People say that the DCF is an intrinsic valuation methodology, whereas Public Comps and Precedent Transactions are relative.
But is that correct?
No, not exactly
The DCF is based on the company’s expected future cash flows, more so than the others, so in that sense, it is “intrinsic valuation.”
But the Discount rate used in a DCF is linked to peer companies (market data), and if you use the multiples method to calculate Terminal Value, that multiple is also linked to peer companies.
